The End of the Chinese Economic Miracle?

By Desmond Lachman of AEI.

"Even before the start of the latest round of the US-China trade war, the Chinese economy was in deep trouble. Now that another round of that trade war has started, it is difficult to see how China will extricate itself from its economic troubles anytime soon. A further slowing in the Chinese economy could have serious implications for the world economy in general and for China’s Asian trade partners in particular. After all, China is the world’s second largest economy and until recently was the world’s main engine of economic growth.

In recent years, troubles have come to the Chinese economy not as single spies but in battalions. First, President Xi’s ill-advised zero tolerance Covid policy caused an abrupt slowing in economic growth by keeping many workers at home. Then, the bursting of China’s epic housing and credit market bubble resulted in a wave of property-developer loan defaults, falling house prices, and acute local government financial strains. As if this were not sufficient reason for concern, President Xi managed to sour domestic and foreign investor confidence in China by his heavy-handed crackdown of the country’s tech sector. 

The net upshot of these troubles is that even according to the official figures, Chinese economic growth has slowed from the seven- to eight-percent range to which it had been accustomed to barely five percent last year. At the same time, the country is now experiencing mild price deflation that could exacerbate the private sector and local government debt problem and delay consumer spending decisions. Meanwhile, despite a questionable revision to the method by which youth unemployment is measured, such unemployment now exceeds a socially worrying 18.8 per cent.

The normal way for a country to stabilize an economy in the midst of the bursting of a massive housing and credit market bubble is to provide it with substantial fiscal and monetary policy support. However, China’s present situation is that neither of those means of supporting the economy appear to be available to it.

Given the parlous state of the local government finances, President Xi is understandably reluctant to add further to China’s public debt problem by engaging in large-scale budget stimulus. He also does not want to relax credit conditions since that would exacerbate China’s housing and credit market bubble and simply delay the eventual day of reckoning for the earlier housing and credit market excesses. This essentially leaves China with the option of trying to export its way out of its problem by cheapening its currency and by dumping its excess industrial capacity abroad.

The fly in the anointment for China pursuing that option is that no country, and especially the United States, wants to receive China’s excess industrial capacity. Germany, Europe’s largest economy has been in recession for the last two years and is supporting Europe’s drift towards erecting trade barriers against China. Meanwhile the United States has now slapped on an additional 10 percent import tariff on China and is in no mood to tolerate the Chinese use of exchange rate policy to promote its exports. On the contrary, it is hiking tariffs with the explicit objective of reducing America’s reliance on Chinese imports.

All of this heightens the chances that like Japan before it, China will now experience a lost economic decade of painfully slow economic growth. That does not bode well for a struggling global economy that in the past has relied on the Chinese economic locomotive to get the world economy moving. If there is a silver lining to this sorry saga, it is that China might help the Federal Reserve in its struggle to get inflation under control. It might do so by reducing its hitherto voracious demand for internationally traded commodities which could send their prices falling."