9/30 – International Economics Story

In trying and failing to fix China’s economic crisis, Xi Jinping himself has long resisted advice from the IMF and others to rebalance the economy towards consumption instead doubling down on high levels of investment and China’s geopolitically controversial export like growth model. Last week we got the biggest indicator that the CCP was taking weak consumption seriously when China’s central bank announced a slew of stimulus measures designed to bolster flag in consumer confidence. 

On September 24th, the People’s Bank of China (PBoC) responded by cutting interest rates, lowering reserve requirements for banks, and taking measures to reduce the cost of existing mortgages, benefiting 50 million households by around 150 billion yuan ($21 billion) annually. Pan Gongsheng, the central bank’s governor, hinted that further reserve requirement reductions might follow later this year.

The central bank will assist companies in repurchasing their own shares by refinancing the bank loans used for that purpose. Additionally, it will support securities firms, insurers, and other institutional investors in raising capital by strengthening their balance sheets. These institutions will be able to borrow safe, liquid assets like government bonds from the PBoC, using their riskier, less liquid assets, such as stocks, as collateral. The total size of these measures amounts to 800 billion yuan.

According to Reuters, the Chinese government plans to issue an additional 2 trillion yuan in bonds, equivalent to roughly 1.5% of the country’s GDP. Just as significant as the amount raised is how the funds will be used. Half of the money will be allocated to mitigating the risk of local governments defaulting, while the other half will be aimed at boosting spending by households and businesses.

A portion of the second trillion will be invested in the government’s “cash for clunkers” program, which incentivizes businesses and households to replace outdated equipment, vehicles, and appliances with newer, greener alternatives, ranging from electric cars to smart home devices like “smart toilets.” The remaining funds will go toward financing a monthly allowance for growing families—around 800 yuan per child, excluding the first. According to the 2020 census, 114 million children could benefit. Although China’s government has historically resisted handouts due to concerns about promoting laziness, this time it hopes the financial support will encourage people to have more children.

The question now is if these new plans and stimulus packages as part of Xi’s plan will be enough to fix Chinese economic woes. 

Many equity investors have already made their move, with China’s stock market surging by more than 15% last week. [The Economist] 

Chinese stocks surged to their largest single-day gains in 16 years on Monday September 30, with domestic A-shares reaching a record-high turnover as investors rushed to capitalize on a sharp rally triggered by Beijing’s latest stimulus measures. 

The CSI300 blue-chip index has now climbed nearly 30% from its February low, which, by some market standards, signals a bull market. However, most of these gains have occurred rapidly, over just a few trading sessions since last week.

Many traders, anxious about missing out on the rally ahead of a week-long holiday beginning on Tuesday, contributed to boosting the CSI300 index, which surged 8.5% by the close, bringing its five-day gain to over 25%—the strongest increase on record. [Reuters] 

But will this kind of responsive growth last for long? 

The root cause of China’s economic crisis is the fact that consumption accounts for a disproportionately small share of its overall GDP. GDP is often defined as the sum of four things: government spending, business investment, household consumption and the difference between exports and imports. 

Household consumption makes up a disproportionately small fraction of Chinese GDP, somewhere around 40%.  This means that your average Chinese person doesn’t really buy or consume that much stuff, and the Chinese economy is instead mostly driven by exports to foreign consumers.  

This is understood through a variety of mechanisms, including an undervalued currency and the fact that China essentially underpays its workers keeping them poor and to keep Chinese exports competitive. All the main elements of China’s wider economic crisis interact with this reality. Their deflationary crisis for example is in part because Chinese families just do not have enough disposable income.

They don’t have enough money, so many have to take out large and unsustainable mortgages. Also, local governments have accrued large fiscal debts because they invest in big infrastructure projects such as high speed rail or massive bridges. 

Chinese consumers just aren’t economically active enough to actually make productive use of these Investments which means they don’t produce. 

China’s export crisis is heightened due to the fact that Chinese manufacturers can’t sell in high volume to their own domestic market, because again, Chinese consumers don’t have enough money. Similarly, Chinese youth unemployment rate is partly due to educational inflation but it’s also because as exports decline, China’s domestic economy doesn’t have the strength to create enough jobs.

Opinion: 

China could have taken two broad approaches to tackling its economic despairs. It could revert to the old playbook of doubling down on investment and exports by subsidizing Chinese industry. Or, it could increase consumer demand through stimulus packages for households or improving their social safety nets. If households don’t have to save up in the case of unemployment or future hard times, then they would be able to spend more. This would also reduce their trade surplus. 

It seemed for a while that Beijing had committed to doubling down, as Xi Jinping refused to bail out the local government or the housing sector, and instead were looking to new productive forces and doubling down on their industry by boosting high tech sectors like AI, EVs, and semiconductors. 

The CCP recently acknowledged it was aware of the problem of weak domestic demand but prioritized modernization and investing in their technological development and staying internationally competitive. 

Many economists questioned how a focus on technological innovation and doubling down on industry investment and manufacturing could solve a domestic housing crisis. There seems to be a noticeable concrete difference in the economic philosophy between a national government like China versus the United States. The CCP and its leaders seem to be advocating for the approach that technological innovation is what will lead to growth and a strong economy. The United States and many Western countries hold the belief that a healthy and well-balanced economy is the prerequisite condition and catalyst for innovation in the private sector. 

Two key instincts have shaped Xi Jinping’s approach to China’s macroeconomic policies since he took power in 2012. He has been reluctant to offer consumer handouts, believing they encourage complacency, and has avoided aggressive economic stimulus, unlike the significant fiscal and monetary measures deployed by his predecessors in November 2008 during the global financial crisis. However, China’s economic struggles over the past year have tested Xi’s convictions. This week, just before the 75th anniversary of the People’s Republic of China, Xi appears to have softened his stance, allowing for the most substantial stimulus package since 2008. Chinese stocks had their best week in 16 years, while Hong Kong’s markets saw a surge not experienced since 1998. Some analysts have even started using the term “bazooka.”

The Chinese have been going full force on expanding their electric vehicle industry as of late, with a notable breakthrough in affordability that rivals global competition and threatens markets like the EU. However, these developments have virtually ignored the economic problems that exist on their domestic front, including consumer spending, a housing slowdown, and a consistent 15-month deflationary spiral. 

In a briefing earlier last week, China’s Central Bank announced a dramatic stimulus package for the Chinese package. This is one of the largest of its kind since at least the Covid pandemic. Most of this package was directed at the housing sector, with reduction in mortgage requirements for second homes and cut the reserved ratio for banks. This frees up cash for banks to lend to prospective home buyers. 

Some support for Chinese equities which gave a noticeable boost to all of China’s major stock indexes. The government also has plans to recapitalize the banking sector. 

Whether this emergent stimulus package will actually be sufficient in fixing China’s economic woes depends on a few factors. This will not be enough of its own and for right now is like throwing a cup of water on a house fire. Things will only turn around if this is the first of many packages and the first step in an overall shift in economic policy. This package on its own will not be nearly enough to fix the housing crisis and there will need to be more focus on poor households. 

It also depends on whether or not this is coming too little too late considering China’s deflationary track has been going for over a year now. This package might raise consumer stock prices for a little while but there are still many question marks regarding whether this will actually be enough to restore long term consumer confidence. Super loose stimulus is not always enough to restart an economy, especially if the trends have formed and consumer pessimism has set in.