Lessons From China’s Economic Shift

*Originally published September 15, 2023

By Tim Courtney, Chief Investment Officer

Lately, the spotlight has been on China and its economic trajectory, particularly in relation to its real estate sector and mounting debt concerns. Just a decade ago, China's real estate market was on an unparalleled upswing, with investments pouring into construction projects across the country.¹ This economic boom seemed poised to position China as the global economic powerhouse. Alongside this expansion, China was offering cheap funding to other countries to further their global influence.² It was largely accepted that it was only a matter of time before China would become the world’s largest economy and its most influential country.

However, since the COVID pandemic, that conventional wisdom has taken a notable turn. Most recently, both China’s consumer price index and producer price index fell 0.3% and 4.4% from a year ago, respectively.³ In fact, The Wall Street Journal recently argued that China’s currency has weakened too far and too fast for its central bank.⁴

Below, we examine key takeaways from China’s economic shift.

1. Overestimated Growth Contribution. The assumptions by many companies that China would provide sales and earnings growth are proving false. American tech companies and European luxury goods companies are seeing growth levels well below their expectations.¹ This not only impacts those companies’ stocks but also reverberates throughout global commodity markets, creating additional challenges. Rather than growth, China is grappling with a deflationary environment.³
2. Government Structure. China's one-party (and more accurately one-man) governance system has led to huge capital and labor misallocation. Key decisions made by few people with relatively little information has led to bubbles, debt and resources wasted on projects with bad cost/benefits. Of course, that happens in the U.S. too, but when leaders listen to price systems rather than trying to manipulate them, outcomes are usually healthier and resources are less likely to be wasted.
3. Trends Aren’t Forever. The nature of economic trends serves as a stark reminder here. Many investors have a tendency to discover a trend, bet heavily on it and extrapolate the trend indefinitely. Up until just recently, China's climb was seen as unstoppable.⁵ Now though, opposite headlines are being written.⁶ We shouldn’t extrapolate current trends forever and we shouldn’t let headlines dictate our views and decisions.

China's situation reminds us that healthy economies require markets and prices to provide feedback to leaders who need to have the discipline to acknowledge them. It also reminds us that today’s headlines are impermanent and that by the time we see them, the market may have already changed. If you have any questions, please contact your Exencial advisor.

Sources: 

1. The New York Times (8/21/23) — What to know about China’s real estate crisis
2. CNN Business (3/28/23) — China gave huge loans to some countries. Now it’s spending billions to bail them out
3. CNBC (8/9/23) — China’s consumer prices fall for the first time in 2 years, as fears of deflation grow
4. The Wall Street Journal (7/5/23) — China’s weakening currency is becoming a headache for its central bank
5. Bloomberg (1/18/21) – China’s Covid recovery to help overtake US as largest economy
6. Bloomberg (9/4/23) – China slowdown means it may never overtake US economy

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