In the not-so-distant past, China’s economy was widely referred to as the “Madoff economy” on Wall Street, drawing parallels to Bernie Madoff’s fraudulent investment scheme. Just like Madoff, who consistently reported impressive returns regardless of the actual performance of his investments, the Chinese government consistently reported 7% to 8% growth every year, regardless of the true state of the economy. Consequently, many analysts on Wall Street were skeptical of these numbers and believed that China’s economy was growing at a much slower pace than officially stated.
Now, with the “official” numbers dropping to 4% to 6%, one can only wonder how dire the situation in the Chinese economy truly is. To combat this negative perception, the Communist authorities have resorted to new tactics by instructing local analysts and pressuring foreign investment banks not to make negative comments on the economy. This misguided attempt aims to boost domestic and foreign confidence, curb capital flight, and prevent the economy from slipping into a deflationary spiral.
It is important to recognize that China’s economic troubles can have a significant impact on the United States, especially considering China’s status as the world’s second-largest economy and its recent role as the main engine of global growth. On the bright side, a struggling Chinese economy can provide some relief in terms of inflation, as it leads to falling Chinese export prices and lower international oil and food prices.
However, the Communist officials seem to overlook the fact that their efforts to muzzle the analysts may actually have the opposite effect on investor sentiment. At a time when foreign companies are trying to reduce their dependence on China’s supply chain and the government is heavily intervening in the tech sector, casting doubt on the reliability of experts’ reports is the last thing the Chinese government should be doing.
As President Xi Jinping lifts COVID restrictions, the Chinese government finds itself in defense mode as gross domestic product fails to rebound. This raises doubts about whether China will even achieve its modest 5% growth target for the year. Additionally, exports are declining, producer prices have been consistently decreasing for the past nine months, consumer prices are flirting with deflation, and youth unemployment has skyrocketed to over 21%. These worrying trends indicate that China’s housing and credit market bubble may be bursting.
Over the past year, numerous Chinese property developers, including the prominent Evergrande, have defaulted on their loans. House prices have been steadily declining, housing starts are experiencing a significant slump, local governments are facing financial difficulties due to plummeting land sales, and there is an alarming number of unoccupied dwellings in the housing market.
All these factors, combined with the fact that China has seen a larger credit market bubble in the past decade than Japan did before its lost decade in the 1990s, raise concerns about China potentially entering a Japanese-style balance-sheet recession. In such a recession, as prices drop, households tend to cut back on spending in an attempt to reduce their debt burden and improve their balance sheets. Unfortunately, this reduction in aggregate demand hampers economic growth.
The first step towards much-needed economic reform in China would be for the authorities to acknowledge the excessive reliance on unsustainable credit expansion and housing market activity. Rather than stifling external economic analysis, Chinese policymakers would benefit from heeding the warnings of analysts and taking proactive measures to steer the Chinese economy away from the path that leads to a lost decade, similar to Japan’s experience. Failure to do so could result in increased deflationary pressure that will impact the global economy.
Desmond Lachman, a senior fellow at the American Enterprise Institute, has a wealth of experience in international finance, having worked as a deputy director in the International Monetary Fund’s Policy Development and Review Department and as the chief emerging-market economic strategist at Salomon Smith Barney.
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