Entering 2023, the relentless drumbeat of Wall Street consensus was pounding out one consistent rhythm: China is back. After years of lockdowns and suppressed output, economists and investors cheered the end of Beijing’s zero-COVID policy and the economic boom that was sure to follow. The colossus-in-waiting that is the Chinese consumer was about to roam freely, analysts said. This was great news for the whole world — everyone would benefit from the globe’s second-largest economy getting healthy.
But six months into the year, Wall Street’s dreams for the country are turning into a nightmare.
Far from an economic explosion, China’s recovery from COVID has been weak. Industrial production has disappointed. Trade — both imports and exports — has slowed markedly. There is debt everywhere, especially in property development, which makes up 30% of the economy. Trading partners are upset for a litany of reasons, from human-rights abuses to concerns about the government’s increasing role in the country’s commerce. The private sector — which was expected to drive most of China’s bounceback — is running scared.
The fizzled reopening isn’t just a short-term disappointment, it’s a sign that the old China is gone. The mechanisms that drove the «Chinese miracle,» a triple-decade transformation that made the country an international force, have broken down. The bubble in China’s property market finally popped. And because of real estate’s central role in the economy, the painful process of absorbing those losses will continue to suck money away from Chinese households, banks, and China’s massive web of local governments. China’s working-age population is getting old, and there are fewer young people to replace them than at any time in the country’s modern history. Exports remain key to the economy, but countries that once championed free trade have turned from globalism to protectionism.
As opposed to slumps in the past, it also does not appear that Beijing is going to step in and reverse this downward trend. Chinese President Xi Jinping has instead been preparing his people for an era of lower growth, making it clear that’s what the economy can achieve in its current state, and it’s also the structure he likes.
And while Wall Street is trying to put on a good face, banks like JPMorgan are starting to write notes to clients asking if it’s even worth investing there. This is one of those questions where if you have to ask, that in and of itself is a problem.
Other big-time investors are full-on ditching the once-promising country. The legendary hedge-fund manager Stanley Druckenmiller, a longtime believer in China’s growth who described the entrepreneurial energy in the country before COVID as «New York on crack,» painted a grim picture of the future for a crowd of attendees at the Bloomberg Invest Conference in June.
«Looking out 10 or 15 years, I just don’t see it. Unless there’s a change in power at the top, I think that’s going to be a very undynamic economy,» he said. «We’re expecting a sugar high and some kind of robust growth there for the next six to nine months, but looking out, I do not look at them as a big challenge to the US in terms of economic power and growth.»
Instead of the exuberant recovery that Wall Street was expecting, we are witnessing the last gasps of the Chinese economic miracle. And almost no one was ready.
Don’t call it a comeback
Analysts thought that 2023 would provide us with a glorious rally in the Chinese stock market. Morgan Stanley and Goldman Sachs said it was coming. Bank of America’s forecast argued that while recessions would grip the rest of the world, China would be a «notable exception» and that country’s reopening would be a «reprieve.» Expectations for China’s growth hit a 17-year high.
It was supposed to be a great time, but it’s barely been good. In April, China’s economic data came in weak largely across the board. A survey of manufacturing executives by China’s National Bureau of Statistics found that activity in the country unexpectedly contracted. Industrial production, another measure of how much the country is making, grew by 5.9% from the month before — solid but well shy of the 10.6% increase that analysts were expecting. And the property market, which is a key part of government revenue, also stalled out, with land sales falling 22% in the first quarter of 2023. In a note to clients aptly called «That’s It?,» the Societe Generale economist Wei Yao calculated that retail-sales growth compared to the month before was basically zero.
Analysts think May might bring some reprieve. Car sales seemed to be recovering, which should cheer Beijing. And analysts at China Beige Book, a service that surveys Chinese businesses, predict that the retail and service sectors will likely surprise to the upside. «CBB’s revenue and profit margin indices improved for a third-consecutive month in May. They also marked the strongest single-month readings for each indicator since the initial Covid downturn of early 2020,» they wrote in a recent report. But that doesn’t mean the boom is just arriving a little late.
«The Chinese economy may be reopening, but it’s not going to be reactivating,» Leland Miller, the founder of China Beige Book, told me. This recovery is a «head fake,» he said.
The problem is that while consumers may be picking up, the biggest drivers of the Chinese economy — property and exports — are going to stay dormant. Consumer consumption makes up about 37% of the Chinese economy (in the US that figure is about 70%). So a return to normal activity from consumers is helpful, but it’s not enough to carry the economy. China was never going to be able to deliver on the miracle reopening that Wall Street wanted without getting the wheels of its massive export and property machines moving. Beijing has tried to shift the country toward a consumption model, like the US, but exports still make up 20% of China’s economy. In May, outbound shipments declined by 7.5%, the first decrease this year. The slump is largely due to a general global economic slowdown, but it’s also due in part to unfavorable geopolitical dynamics that seem to worsen by the day. Imports, an important indicator of China’s domestic health, also slowed. Beijing put the entire economy in a deep freeze during COVID, but that doesn’t mean reopening will heat things up. China’s economic return will be lukewarm at best.
«Things will improve in 2023, and then you’ll have the same structural issues slow things down in 2024, 2025,» Miller said. «Then people will stop paying attention to the cyclical and start paying attention to the structural problems, which are a feature of the economy for years to come.»
Not beast mode, blob mode
China is facing a long, painful road ahead, and policymakers in the Chinese Communist Party seem uninterested in market-oriented solutions to ease their journey. «The root causes of the disappointing recovery look increasingly structural — a deleveraging mindset and a more permanent loss of animal spirits,» Societe Generale’s Yao warned in her recent note.
At the core of China’s structural problem is debt. For years, the country’s growth came from infrastructure and property development, a lot of bad investments were (and still are) made because there was no concern for whether or not there was real demand for all of it. There was not. Now that bill is coming due. Beijing finally got real about the debt it helped fuel in the property market and cut off its supply of cheap credit in order to cool it down. But the ramifications of this change go beyond an implosion in one sector of the economy. We’re watching sacred cows being slaughtered here.
For years, China’s local governments funded themselves largely by selling land to property companies. In the US, we fund local governments through property taxes. China doesn’t have that, and smaller, poorer provinces are already begging for help because the way they used to raise funds is no longer available. Imagine US politicians trying to fix a problem like this. Oh, wait, no. Don’t. I want you to have a nice day.
The breakdown in local financing has a real and immediate impact on Chinese society. As the credit flow slowly got choked off, property companies started selling apartments before they were built, funding themselves on the backs of Chinese consumers. But as the market has gone bust, some developers aren’t making good on their promises to the people they sold to, leaving households up the creek. Property was supposed to be a safe investment for China’s savers. Over 70% of China’s wealth is tied up in real estate. It was the investment that secured a family’s place in the middle class. And the problem isn’t just for older people nearing their twilight years — the property bust is hurting the prospects for the next generation, too. Some starved local governments are raising college tuition fees as high as 54% at a time when youth unemployment is over 20% and a record number of students are trying to get a higher education.
Working all of this debt and destruction through the economy equals deflation and slow growth. «You have to set policy for the weakest part of the system,» Logan Wright, a partner at Rhodium Group told me. «That means interest rates stay low, a weaker currency, and outflows.» Slower growth isn’t just a shift, it’s a historic end to an era.
Miracles only last so long
In this environment, trade is critical to China. Now would be an ideal time to ramp up exports, to bring in capital from the outside world. But as I’ve argued many times, Xi is a closer, not an opener. Geopolitical tensions have the US — China’s biggest trading partner — «de-risking» from China (not decoupling, the powers that be have decided that word is too toxic). Many US corporations are looking to move operations elsewhere, either by reshoring them to the States or by «friendshoring» them to more ideologically aligned countries. Last year, China made up 50.7% of US imports from Asia; that’s down from over 70% in 2013, according to the management-consulting firm Kearney.
For the rest of the world, moving away from China is inflationary — it will take time and money to set up factories closer to home. The complexities of dealing with a sputtering Chinese engine will be a problem for many countries that have become tangled in Beijing’s economic web. The end of the miracle will be a pain for many investors and markets — it will make things less stable, and the world will have to find new sources of growth.
In a world of free trade and trust, China’s problems would probably be easier to solve. But that’s not where we are. China’s economic model was built on a world that embraced globalization. We are in a world of protectionism, cautious investment, and regional alliances. As investors move their attention from short-term COVID improvements, they’ll start seeing that long term, the Chinese economy has completed its transmutation from strong, rapid growth to a long, slow grind. Like many sea changes in markets, this may seem like it’s happening slowly, but one day it will feel like it’s happening all at once.