7 minute read
As many of you know, China’s economy has struggled in recent years. Back in January, I highlighted how China’s economic outlook was far weaker than many realized - with collapsing property prices, weak consumer spending, a poor demographic trend, and banks bloated with toxic debt (read here).
Furthermore, I hypothesized that China would try to "export its way out of a slowdown." (also read here).
- Simply put, because of weak domestic consumption, China would flood the global market with its excess goods to try and find buyers somewhere else.
The unsurprising drawback? Well, it sparked significant tension abroad, as other nations pushed back to protect their own industries and job markets by raising trade tariffs against China.
So, with a struggling domestic economy and an increasingly hostile global trade environment, how could China hit the ambitious 5% growth target Beijing set before the year is over?
Well, to tackle this head-on, Beijing fired a stimulus bazooka - its 'whatever it takes' moment - to try and breathe life back into the economy.
And as a result, the China Securities Index 300 surged nearly 20% by September 30, before markets closed for a national holiday from October 1 to 7.
Figure 1: MarketWatch, October 2, 2024
This has set off a wave of ripple effects in markets expecting that the world’s second largest economy would finally get a pulse going.
But the question I ask remains: Can China’s stimulus package turn things around? Or is it simply a short-term spurt to kick the proverbial can?
Let’s take a closer look.
China's Latest Economic Stimulus Measures
Last week - late September 2024 - China unleashed a flurry of moves to boost its economy1 in order to hit their 5% GDP target.
For instance, they cut rates, lowered bank reserves, and aimed to get money flowing into the economy. For stocks, the government set up funds to support share buybacks and future equity growth. They plan to bolster big banks and consider issuing special bonds to keep money moving.
- In short, they’re doing whatever it takes to try and pump cash into the system and prop up markets.
But keep in mind that at the meat of it, China’s latest stimulus centers on reviving the property sector - once a growth pillar but now in steep decline.
Trying To Reinvigorate China’s Property Sector Is Key
China’s real estate sector has been sinking like a stone over the last few years, which has greatly damaged consumer confidence and economic growth.
Figure 2: CaixaBank Research2, June 2024
Remember, China’s real estate sector plays a huge role in their economy.
For example:
- Around 70% of household wealth is tied to real estate, essentially making homes consumer piggy banks3. And - according to estimates from Bloomberg Economics - every 5% drop in home prices in China potentially erases 19 trillion yuan (around $2.7 trillion) in housing wealth4.
- Meanwhile, China’s housing market previously made up over 25% (at times up to 29%) of its GDP, compared to the 15-18% average in the U.S.5 – thus showcasing the sector’s outsized role in China’s economy.
Therefore, with falling home prices and developer debt issues, Beijing’s stimulus is easing restrictions – such as lowering mortgage rates, relaxing purchase rules in big cities, and providing favorable lending terms to developers.
These moves have already spiked investor confidence it seems, with Chinese property stocks reaching their highest level in a year, indicating optimism that these measures could lift the struggling market (at least in the short term).
The point is, China's property market is critical to its economy – so keep an eye on it.
China’s Credit Expansion and Infrastructure Investment
To stimulate growth, China is encouraging credit expansion and investment by reducing reserve requirements (RRR) at banks. This means that borrowing becomes cheaper for businesses and households, thus aiming to boost investor confidence and stimulate spending across the economy.
Meanwhile, the government is promoting infrastructure development to spur economic activity, following a pattern of using large-scale investments to drive growth during economic slowdowns.
Ironically, years of excessive infrastructure spending partially contributed to China’s economic troubles. But, like the saying goes, “If the only tool you have is a hammer, you tend to see every problem as a nail.”
Mind the Bigger Picture: China’s Local Government Debt Problem
While the new stimulus measures are clearly welcomed – although delayed - they come amid serious challenges facing China.
Figure 3: MacroMico, 2024
And while this is steep, what’s really worrying is the off-balance sheet debt that local governments have hidden. . .
To give you some context, local governments (essentially provinces/states) had for years taken on huge “hidden” debts – estimated over $11 trillion7 (which is over 60% of China’s GDP alone) - to fund infrastructure projects with low returns. And now, these local government financing vehicles – LGFVs - are a bigger threat to banks than even the real estate sector.
- This is what I'd call a "grey rhino" – aka when risks are so obvious and substantial but mostly ignored.
All this debt could limit the effectiveness of increased lending from the stimulus, since too much debt is already a major problem.
But for now, it at least makes borrowing costs cheaper for those in need.
The Road Ahead: Will China’s Stimulus Be Enough?
China’s stimulus measures are vast, aimed at jumpstarting a slowing economy and preventing further decline.
But will they have a lasting impact? That’s uncertain.
While these steps may boost lending and spending in the short term, they don't address deeper, underlying issues – such as aging demographics, mounting debt, and anemic consumption.
Meanwhile, Beijing’s usual playbook – such as funneling money into banks and infrastructure - is more of the same, bringing its own set of risks.
The massive debts, diminishing returns, and wasteful spending are the consequences of years of such stimulus measures.
Most of these projects don’t even create real economic value, which is why they’ve slid toward insolvency.
- Said another way, building for the sake of building can mean repaving roads that don’t need it or rebuilding railroads already in good condition. Sure, it can boost jobs and demand in the short term, but that’s not a sustainable long-term plan.
Still, China’s new stimulus is at least a first step toward recognizing the problem. And while it's not a silver bullet, the immediate lift to property stocks and financial markets is real.
Maybe the surge in asset prices will reinvigorate confidence – sparking a new wave of growth? Who knows. It’s not like we haven’t seen it happen before.
As always, this is just some food for thought. And time will tell if it’s enough to balance an economy so far out of sync.
Sources:
- China’s Stimulus Blitz: What We Know So Far and What to Expect - Bloomberg
- China’s real estate sector: an updated diagnosis (caixabankresearch.com)
- Feeling poorer: Property slump hurting Chinese consumers, clouding recovery | Reuters
- China's middle class battered by real-estate meltdown | Fortune
- China’s Property Market: Explaining the Boom and Bust – The Diplomat
- China’s Macro Leverage Ratio Edges Up to Fresh Record - Caixin Global
- Trillions in Hidden Debt Drove China’s Growth. Now It Threatens Its Future. - WSJ
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