China: 2025 Update
Which country will win the “productivity race” and have more influence on shaping the new world order?
Despite meeting its target 5% GDP growth rate (which it always does but nobody believes), China is believed by most to have plunged into economic depression in 2024. “Depression” is prolonged economic funk but doesn't have to meet the technical definition of “recession” (two consecutive quarters of GDP contraction). This article attempts a deep dive on “what’s underneath the hood” of this depression, and to update the trajectory I previously laid out here and here.
At its core, China’s economic problem is over-investment resulting in overcapacity. Its domestic consumer market is not big enough to absorb this overcapacity, so it has to continually rely on export to keep its economy afloat. But tariffs and other controls imposed by multiple nations are now choking off its exports (hundreds of thousands of unsold EVs are piling up in Rotterdam and other ports). Worse, the exodus of foreign companies operating in China over the past three years (due to security concerns stemming from China’s blatant anti-West posture) purportedly left 30 million unemployed up and down the supply chains. This unemployment problem has only gotten worse.
Why is China's domestic consumer market insufficiently developed after all these decades of “miraculous” growth? Simply put, the CCP wants it so (explained in the 4th paragraph of this article). By policy, the central planners of China's control economy direct its state controlled banks to fund targeted industries and companies. These banks in turn maximize their funding capacity by way of financial repression — offering interest well below inflation rate for common folks’ savings. Meanwhile, while CCP members have generous pensions, common folks have no Social Security-like safety net. Having to self-fund retirement with paltry interest from savings is a huge reason behind China’s weak domestic consumer market. Put another way, in its wealth re-distribution role, the CCP favors its state owned banks and strategic enterprises over its populace.
Historically, the struggle between central and regional power (i.e. the flip flopping between unification and balkanization) is the hallmark of China’s dynastic changes over millennia. Today, China’s central planners put its provincial governments on a pretty tight leash. The provincial governments have to contribute a certain portion of the nation's GDP and meet other growth metrics, but fund themselves. To do so, provincial governments habitually “loosely interpret” Beijing’s directives, fabricate “good news” (one reason why China’s official statistics are notoriously not credible) to appease it, while coming up with ingenious ways to generate local income and line their own pockets (hence the never-ending anti-corruption campaigns). The most significant source of such local income has been the selling of land to developers, with more income downstream from helping the developers build and sell. This gig also conveniently solves the common folks’ savings problem. Buying a condo whose price rises rapidly with occupancy demand from industrialization and urbanization yields “hella better” return than parking money in a bank or speculating in a stock market whose constituent companies can be destroyed overnight by the central planners at will. Buying a second, third, or even fourth home (even with pooled capital) can mean instant riches and early retirement!
Thus began China's real estate bubble, — which became the biggest asset class in the entire world. During China’s unbridled building boom, China used 6.6 gigatons of cement in just three years (between 2011 and 2013), — more than the United States used throughout the entire 20th century. It is estimated there are now 90 million empty units (enough to house the entire population of the United States and then some) in residential high-rises dotting the skylines of at least 50 “ghost cities” all over China. No one ever had any intention of living there but they got built anyway because it was “profitable” for everyone: Provincial governments got a lot of revenue, common folks had an investment avenue, and the central planners could boast impressive GDP growth. In hindsight, this has been a gigantic bubble destined to burst from the get go.
A simple definition of a financial bubble is “income streams failing to materialize to pay back capital investment”. Empty, unsold units befit that description. But the problem is bigger. The developers have been running a Ponzi scheme all along — relying on advanced payments from new buyers to finish developing earlier already-paid-for units. When new buyers dry up, unfinished projects add to the problem of empty units. It is estimated there are 48 million units (the entire housing capacity of Germany) sold but unfinished. This means most of these 48 million homeowners are paying mortgages but either have nowhere to live, or no unit to rent. Even if the central planners throw trillions to finish these units at the exclusion of all else, it will take eight years to do so do so, at the current run rate. No wonder grievances mount and social unrest ensues.
So why have new buyers dried up? First, there is the Chinese “population bomb” (combination of aging and shocking drop in birth rate). Except for a handful of top tier cities, every major urban area in the country has seen significant population decline since 2020. This adds to the already collapsing housing demand from economic depression (mentioned in the first paragraph). The industrialization and urbanization engine is now going in reverse. Migrant workers in the major cities are returning home to the countryside. With home sales dropping by 70 and 80% and prices dropping by half in some cases, the real estate gig is up, with participants up-and-down the transaction chain holding the bag.
Clearly, provincial governments and local banks (with their lose lending during the boom years) encouraged the blowing of the now bursting bubble, causing financial ruin for many in the populace. Running out of cash and no longer able to raise new funding, provincial governments and local banks are now having a hard time providing even basic services. Worse, they owe their employees months of salary backpay. Banks first limited withdrawals and later outright froze depositors' savings. Elsewhere, bankrupt developers are selling off empty apartments for 10 cents on the dollar. This may delight the new buyers but obviously enrages previous buyers who paid much higher prices and are now sitting on huge losses.
This economic depression is much worse than a garden variety cyclical recession, because the gargantuan debt driving the over-investment phase is now deleveraging. This is highly deflationary for enterprises (I detailed the Evergrande and Country Garden implosion in this article), the banking sector, and consumers (70% of common folks’ savings is locked up in residential real estate and now many of them are jobless) alike. This depression is set to be long and deep, with many macro and micro implications which make corrective actions either difficult or counterproductive.
Take the depreciating Yuan (natural outcome of economic depression). China runs a value-add economy and needs to first import raw material (with foreign currencies, notably US dollars) before it can export finished goods. A depreciating Yuan means higher input costs which reduces producers’ profit, translating to employee layoffs (and often eventually bankruptcies). Exports curtailed by foreign tariffs only worsens this situation. This prevents China’s central planners from truly implementing their threatened “bazooka bailouts” (i.e. inject sufficient liquidity into the banking system by massively printing). Doing so will only further debase the Yuan and worsen the problem.
China has a legal system only in appearance but never in reality. Mounting social grievances never result in justice but only cover-ups and police oppression. If you can't fight them, vote with your feet. Mass emigration — including the most prominent — has been accelerating. This brain drain and capital flight only diminish any chance for speedy recovery from a economic depression. Much like Japan’s “lost decades”, the epicenter of this depression is the banking sector. Japan’s bank lending then— almost forced by the government — merely went to keep zombie corporations alive and failed to stimulate the nation out of depression. Will China be able to do something else to avoid the same fate?
Well, China’s central planners are fully aware that the age of low cost labor advantage and free shipping lanes (now hotly contested in the South China Sea, the Panama Canal, and even around Greenland) is over for China. But in the face of economic depression and “let rot” and “lie flat” funk, they are not hunkering down and playing defense on the global stage. Xi has redirected state-owned bank lending from the real estate sector to “New Quality Productive Forces”, — moving up the innovation, technology, quality, and thus value chain. This means focusing on strategic industries like EVs, solar and nuclear energy, AI, quantum computing etc., — the very same industries that Trump 2.0 is focusing on. So the “productivity race” (productivity is the only way to grow out of economic depression accompanied by huge debt overhang) is on.
China's first shot across the bow is its announcement of Deepseek on Trump's inauguration day. The timing, of course, was anything but coincidental. China's central planners are essentially “in Trump's face” with this message: “Your plan for American exceptionalism through dominance over technologies is based on a false narrative (only vast resources can win the race). In the days since the announcement this message has proven to be at least partially true. The long term relevance of this (intentionally) disruptive “message” costing NVIDIA $600 billion of market cap, and what “halftime adjustment” the U.S. will make, remain to be seen. But the U.S. clearly has many more competitive advantages over China in setting the rules for the new world order, productivity race notwithstanding. Chief among them in my mind is the manner by which to bring about global currency reset (think of it as a cross between Bretton Woods 2.0 and Plaza Accord 2.0). But that is another subject for another article.
Meanwhile, it’s “game on”.
