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It’s been a busy week. U.S. trade envoys met with their Chinese counterparts in Switzerland, and both sides made significant concessions:

  • The U.S. slashed tariffs on Chinese imports from 145% to 30%.

  • Tariffs on Chinese packages under $800 dropped from 120% to 54%. A planned fee hike was shelved.

  • China reduced tariffs on U.S. goods from 125% to 10%.

  • Most importantly, China agreed to keep talking, addressing broader issues like intellectual property and market access.

Thanks to this, global asset markets rallied.

But let’s be clear - this is just a 90-day truce, a brief window to hash out something bigger. Because even with these cuts, tariffs remain far above pre-trade war levels, and uncertainty still looms.

Both sides had pressing reasons to seek relief. For the U.S., it was about avoiding economic pain - empty shelves, inflation, job losses, and an angry consumer base.

But for China, it seems like an existential crisis. Despite its outward strength, Beijing can’t afford a prolonged trade war with the U.S.

Why? Because China’s economy is wobbling - trapped in a toxic mix of diminishing returns, collapsing home prices, excess manufacturing, and a demographic crisis.

So, let’s take a closer look at these...

Why China Desperately Needs the Truce

At the heart of China’s crisis is a collapsing real estate market, triggering a domino effect across the economy.

1. Chinese Households Are Getting Crushed by Falling Home Prices  

Real estate assets make up over 70% of household wealth in China, rising to 80% in major cities like Beijing and Shanghai (in the U.S., that share is roughly 35-50%)1.

And this wasn’t exactly their first choice.

See, for decades, Chinese citizens have been “financially repressed” - meaning government policies essentially limited their investment options. They could either buy property, buy gold, or open a heavily restricted brokerage account tied to domestic stocks.

Thus, Chinese households poured their savings into real estate (which was seen as less speculative) - often into empty second or third investment properties.

  • Entire “ghost cities” sprang up, with tens of millions of unoccupied homes. In some regions, 20-30% of housing stock is vacant.

And for 15 years, this fueled a “wealth effect” as rising home prices made homeowners feel richer, thus boosting spending and confidence.

But that all changed since late-2021 as prices began falling. . .

Figure 1: St. Louis Federal Reserve, Dunham May 2025

 

Now, a lifetime of savings is trapped in a single, sinking asset for countless millions.

Imagine having almost all your net worth in one thing - and watching it plunge.

The once strong wealth effect has turned negative – households are spending less, their confidence is shattered, and they’re even having fewer kids.

Put simply, Chinese households are stuck in the housing wreckage, and Beijing is struggling to get them out.

2. China’s Local Governments: Drowning in Debt

Think of China’s local governments like U.S. states - they handle most public spending on infrastructure, education, and social services but operate under Beijing’s strict control.

But here’s the problem:

Beijing sets national growth targets, and it’s up to local governments to essentially hit them. To do this, they’ve relied on a simple strategy:

  • Borrow heavily.
  • Spend aggressively.
  • Sell land to property developers.

This approach turned real estate into a financial engine - that is, as long as prices kept rising.

But that engine is now sputtering.

How bad is it? Well, it's hard to say with China's shadow banking system. But estimates show these local governments are sitting on $7-$11 trillion in “hidden” debt - roughly half of China’s GDP.

And it’s getting worse:

  • Revenue is crumbling as land sales continue drying up.

  • Debt keeps growing and refinancing is becoming increasingly difficult, even as the central bank cuts rates (because the assets are worth less and less).

  • Basic services are at risk, with local governments struggling to maintain public services.

Now, Beijing has started quietly bailing out these local governments, but it faces a brutal dilemma:

  • Bail them out: Roll over toxic debt and keep wasteful projects going.
  • Let them collapse: Risk massive defaults, layoffs, and social unrest.

But more bailouts will only amplify the problem.

Because of this, the IMF projects that China’s government sector debt-to-GDP will soar from 117% to 150% by 2030.

So, China’s local governments are caught in a debt trap - one they helped build. And Beijing is left juggling between propping them up and avoiding a full-blown crisis.

3. The Law of Diminishing Returns: A System Crumbling Under Its Own Weight

This is the dark side of China’s growth miracle - a web of hidden debt built on real estate speculation, now unraveling.

China’s dilemma is simple but brutal: It must grow to reduce its debt-to-GDP ratio. But its growth model - real estate, infrastructure, and manufacturing - is the problem.

Here's why:

  • As of 2022, China’s Incremental Capital-Output Ratio (ICOR) hit nearly 9.

  • This means $9 of investment now produces just $1 of GDP growth - a
    clear sign of massive diminishing returns.

  • A decade ago, it cost less than half that to get roughly double the growth.

Imagine hiking in a sandstorm twice as fierce but only covering half the distance.

But this isn’t just a worrying statistic - it’s a trend of what may lie ahead.

  • As of 2024, investment made up 41.1% of China’s nominal GDP - far above the global average of ~25% and nearly double that of advanced economies (~20%).

Yet many projects - especially in infrastructure and real estate - have failed to deliver proportional economic returns, leading to overcapacity and financial strain (clearly).

Simply put, China’s economy is overweight on investment - yet that investment is becoming less effective.

Thus, China’s playbook of pumping credit to force growth is running on fumes. More investment doesn’t mean more growth - it just means more debt, more waste, and more deflation.

4. China’s Real Estate Collapse Is Fueling a Global Manufacturing Glut

But China’s crumbling real estate market isn’t just a domestic issue - it’s triggering a global manufacturing glut.

Why? Because China’s plowed massive investment in the manufacturing sector to offset it (see chart below).

Since the property market began sinking, Chinese banks have flooded the manufacturing sector with loans.

  • For instance, according to the Atlantic Council in Q4 2023, Chinese banks extended nearly $700 billion in new loans to manufacturers - often at below-market interest rates – which was a sharp increase from the previous year. 

To put this into perspective:

  • Globally, manufacturing typically accounts for 16% of GDP, ranging between 13% and 17%.

  • But in China, it's a staggering 28% - far above the global average.

And it's set to get worse. . .

A 2024 UNIDO report predicts that by 2030, China will produce 45% of global industrial output - nearly half of the world's manufacturing7. Meanwhile, the West's share is expected to plummet to just 11%, down from around 16% today.

This surge in manufacturing isn't just about meeting domestic demand - it's about flooding the world with cheap goods to sustain growth. With a weak domestic consumer base, China’s factories rely heavily on finding buyers abroad.

Doubling down on this strategy risks triggering domestic problems: oversupply, falling prices, shrinking profits, and eventual layoffs.

Worse, it threatens foreign industries, sparking trade tensions as countries scramble to protect their own manufacturers from a flood of cheap Chinese imports.

  • Or as I like to put it - every big surge in Chinese exports means other countries are importing their layoffs (aka when China sells more abroad, someone else’s factory feels the pressure).

By trying to offset a property crash with even more manufacturing, China is pouring gasoline on an already burning fire - especially as a trade war brews.

If China stays on this course, it will grow increasingly dependent on foreign markets. But the rest of the world won't just stand by.

As countries push back, China risks a lose-lose scenario: domestic instability and a hostile global market.

Final Thoughts: Can China Escape This Trap?

China’s economic model - debt-fueled growth, overbuilt housing, overcapacity in manufacturing - is running on fumes.

Thus, the truce with the U.S. isn’t just about trade - it’s a bid to buy time.

Yes, the U.S. needs China’s cheap goods. But China needs the U.S. consumer far more.

Without access to foreign markets, Beijing’s manufacturing surge will turn into an oversupply crisis.

The real question is, “Can China change its growth model without triggering mass unemployment, social unrest, or a complete collapse in confidence?”

Who knows, but for now, China looks trapped. And time is running out.

As always, this is just some food for thought.

Sources:

  1. Chinese investors are reconsidering real estate as a means of savings | Fortune
  2. China's population falls for a third consecutive year | Reuters
  3. China Is Building 30,000 Miles of High-Speed Rail—That It Might Not Need - WSJ
  4. Local governments in China rely heavily on land revenue | PIIE
  5. China's 2024 local government land sales see 16% drop in revenue By Reuters
  6. Is China Running Out of Policy Space to Navigate Future Economic Challenges? - Liberty Street Economics
  7. The Future of Industrialization - Building Future-ready Industries to Turn Challenges into Sustainable Solutions
  8. China’s huge trade surplus – where next? – Deutsche Bank

Disclosures:

This communication is general in nature and provided for educational and informational purposes only. It should not be considered or relied upon as legal, tax or investment advice or an investment recommendation, or as a substitute for legal or tax counsel. Any investment products or services named herein are for illustrative purposes only and should not be considered an offer to buy or sell, or an investment recommendation for, any specific security, strategy or investment product or service. Always consult a qualified professional or your own independent financial professional for personalized advice or investment recommendations tailored to your specific goals, individual situation, and risk tolerance. All examples are hypothetical and are for illustrative purposes only.

Information contained in the materials included is believed to be from reliable sources, but no representations or guarantees are made as to the accuracy or completeness of information. This document is provided for information purposes only and should not be considered as investment advice.

Dunham & Associates Investment Counsel, Inc. is a Registered Investment Adviser and Broker/Dealer. Member FINRA/SIPC. Advisory services and securities offered through Dunham & Associates Investment Counsel, Inc.

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