Will China drag on global growth?
Check the market indicators instead of cherry-picking convenient narratives
President Biden has recently returned from his trip to Asia, returning to a domestic economy that has certainly seen better days–historic inflation, a tumbling stock market and a negative GDP print hardly make for a winning combination. In its current fragile state, the last thing the economy needs is an adverse shock coming from overseas. In this post, I’m going to take a cursory look at one contender for such a shock: China. Ultimately, I think that China’s economic struggles are real but hardly unique, and thus are an unlikely candidate to cause major problems for the US.
That said, it’s worth covering why exactly people are worried about China in the short-run.
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Three Reasons for Worry: Property, COVID and Foreign Investment
First, there’s a major slowdown in their property markets. Goldman Sachs analysts are expecting a large increase in defaults this year among property developers, and property prices have broadly stagnated. Property sales fell almost 30% from January-April, with the losses accelerating to 46% year-over-year in April. China’s property market is enormous, with a total market capitalization above $50 trillion (direct comparisons are a little rough, but it appears to be roughly similar to the size of the US real estate market, despite the smaller Chinese economy). These problems are hardly new–people have been worrying about the property slowdown since real estate giant Evergrande started experiencing extreme difficulties last autumn. The authorities recognize this challenge and have been imposing several countermeasures–interest rate cuts, down payment reductions, orders to banks to lend more etc.--but these actions have hardly quieted analyst worries. If anything, they underscore just how concerned the central government appears to be about the state of the weakening economy.
Second, China’s zero COVID strategy has been causing major economic destruction in affected areas. China has a large unvaccinated population among their elderly, and with weaker vaccines and little acquired immunity, authorities have decided to impose rather draconian lockdown measures to prevent community transmission. In Shanghai, these lockdowns have caused major disruptions to their globally central ports. While these measures are allegedly going to end early June (though sometimes it’s hard to tell–stated policy often differs dramatically from actual policy on the ground), prediction markets expect China’s COVID-19 case count to nearly double between now and mid-June and there are rumblings that these lockdowns could spread to Beijing (markets forecast a 20% chance the State Department will issue a “do not travel” warning to Americans, which is what they issued for Jilin, Shanghai and other locked down jurisdictions, in the next week). Tianjin and Xi’an have also begun testing all residents beginning this week, so there is some risk that draconian measures might continue to spread. These lockdown measures don’t just compromise economic activity directly–spending, productivity and investment all plummet when you cannot leave your apartment–but also discourage economic activity more broadly as market participants cannot make comfortable long-term decisions with the risk of a major business disruption looming over them.
Source: World Health Organization
Third, China’s general stance towards foreign investment and domestic regulation has many observers somewhat skittish. In 2021, they shocked many by cracking down hard on the tutoring and gaming sectors. There were murmurs of further crackdowns on “variable interest entities”, which are legal vehicles that allows foreign investors to skirt Chinese laws on foreign ownership of Chinese firms. Those fears seem less imminent today, but the general hostile stance of Beijing towards foreign investment, coupled with the aforementioned troubles, have combined to manifest in historically low levels of foreign direct investment in China in 2022 Q2, alongside historically high levels of foreign outflows. Of course, central government antipathy towards foreign economic activity is hardly new: Beijing has long maintained strict controls over where foreigners can invest and wielded an armada of fairly arbitrarily enforced statues like anti-competition laws and data localization rules. But with a market size so enormous, many were willing to stomach it. In the current environment, that thinking appears to be (somewhat) changing.
So… is this reason for concern?
That said, I am fairly skeptical of the “China collapse” crowd. It’s far too easy to cherry-pick individual sectors to declare that the economy is weak. Those bearish on China seem to have been calling for a meltdown for years, only to be proven wrong time and again. That’s why I’m generally a fan of catch-all metrics and prediction markets that can avoid the hype, weigh the evidence in totality and render their judgment. Yet again, these metrics are fairly sober-minded. Prediction markets, like Goldman Sachs analysts, seem to forecast Chinese GDP growth in 2022 to be around 4%. JP Morgan estimates growth around 3.7% and UBS around 3%. These are far lower numbers than years past (growth averaged 6-7% annually from 2016-19) but far from the “imminent collapse” narrative. It’s also true that the Chinese renminbi has fallen against the dollar, but only back to the level it was in late 2020, and honestly no more so than currencies like the Euro or Japanese yen. And yes, it’s true that the Shanghai stock index has fallen 15% on the year, but that’s actually lower than the S&P 500’s tumble. These hardly seem like market indicators of impending doom.
Source: FRED
In other words, highlighting individual challenges any economy faces runs into scope issues. Without catch-all market-based indicators, it’s impossible for a casual observer to know whether a major uptick in property defaults is a nothingburger or a harbinger of a 2008-style crisis. There are just too many sub-sectors in the economy that an analyst can cherrypick statistics from to tell whatever story they want. Healthy epistemic practices thus demand some humility, and in the face of such uncertainty, deferring to well-known market-based indicators is probably the safest bet.
And what do these indicators say? China faces some serious economic struggles, but so does the rest of the world. It’s always worth monitoring to see if conditions change, but as they stand now, the economic fallout from China’s economic weakness will probably result in moderately large amounts of pain to the Chinese people, without presenting a large macroeconomic threat to the United States.
Let us know what you think in the comments below, and also let us know what you want us to write about next! Until next week,
— W&X