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China: not Japan
“The village elder once told me that if your pig, even after laxatives and an enema, just can’t defecate, you should check if it’s because you forgot to feed it.”
This crude joke, making the rounds on Chinese social media, sums up the bizarre situation the Chinese economy is in.
Faced with sagging demand and a teetering property sector, Chinese authorities have tried nearly everything. They have cut lending rates, mortgage rates, business taxes, stock-trading fees and even admission costs at tourist sites; extended EV subsidies; relaxed regulations; intervened in forex markets; and extended stock trading hours. The one thing they haven’t tried: feeding the pig some fiscal stimulus.
That reflects a two-part calculation, argues Adam Wolfe, emerging markets economist at Absolute Strategy Research. First, the immediate problem the Chinese economy faces is one of precautionary savings sapping aggregate demand. Second, authorities fear the most obvious fix to weak demand, a dose of stimulus, might not accomplish much, partly because of an elevated savings rate.
Wolfe’s is a story about insufficient confidence, pushing back against the increasingly popular narrative of a Japan-style balance sheet recession in China. (For the case that China is indeed facing a balance sheet recession, read Robin Wigglesworth or Martin Sandbu.)
Start with precautionary savings. China’s soft consumption numbers evoke Keynes’ paradox of thrift, in which precautionary high savings in a downturn hurt demand further, encouraging still more savings. Wolfe thinks “zero-Covid PTSD”, including the lethally abrupt reopening process, has pushed up the savings rate, hurting demand, especially for durable goods. Even in the healthier services sector, spending has not kept pace with income growth (light green line below):
Next, authorities aren’t confident that “big bang” fiscal spending can solve the problem. Longstanding fears around high indebtedness apply. Remember that the crisis unfolding in China’s property sector was first prompted by the effort to constrain developers’ dangerous leverage levels. That limits how much borrowing can be used to solve the confidence shortfall, for fear of creating worse problems later on. Households’ cautiousness may be hard to dislodge. Wolfe says the worry is that higher spending, such as direct transfers to households, could just end up getting saved — resulting in a low fiscal multiplier that blunts the efficacy of stimulus.
Christopher Beddor and Thomas Gatley of Gavekal Dragonomics take a similar line in a recent note. They point out that consumer, but not business, confidence is worse than what economic fundamentals would predict, probably reflecting lingering pandemic effects. Their chart below shows that while sentiment in central bank survey data usually tracks real activity, the two have come apart lately:
This, in turn, is denting property sales and consumption. But Beddor and Gatley argue that sentiment should improve as the real economy does:
The most likely reason [for poor sentiment] is simply that China’s economy continues to be volatile; if it records several months of consistent improvement, confidence will further normalise and households will revert to earlier consumption and savings rates, as well as deploy those savings in a less risk-averse manner. The improvement in household sentiment indicators may have been weaker than the improving fundamentals in Q2, but they are still up substantially from before the reopening, and will probably improve further with more consistent economic and job-market outcomes over time.
This is not to deny China’s structural issues. But rather than a balance sheet recession, China appears to be suffering two related but distinct problems: a near-term, fixable confidence deficit and the longer-term, harder-to-fix breakdown of its property investment-led growth model.
Consider the features of a balance sheet recession. One crucial dynamic is falling asset prices forcing deleveraging. But in China, that has only happened in one sector, whereas in the 1990s a broad swath of corporate Japan, including appliance makers and auto exporters, faced unsustainable debt burdens. Outside of Chinese property, “no one is being forced to delever”, says Wolfe.
Even in China’s real estate sector, the drop in prices has been modest compared to the plunge in sales. Official data show an existing home price decline of 6 per cent from the peak. Chinese government statistics are notoriously unreliable, but alternative private data show city-level home price declines of 10-20 per cent. In 1990s Japan, the decline from the peak was more like 40-60 per cent, depending on the measure.
To repeat, the property problems are serious. Goldman estimates, conservatively, that the property slowdown will knock 6 per cent off MSCI China companies’ earnings this year. Wolfe thinks the state will have to directly finance property construction to prevent a wider credit crunch. He says the ultimate goal is to manage decline, shrinking the property sector to something in line with fundamental demand.
That process has been under way for several years, though, part of a larger (and so far lacking) transition away from property investment as China’s economic engine. Fiscal stimulus can’t solve that problem. But it can offset the confidence deficit. Until the zero-Covid reopening is fully in the rear-view, it’s too early to start declaring China the new Japan.
One good read
Top-10 Goldman shareholder likens Goldman employees to Maoist guerrillas.