China will not come to the rescue

For most of the 21^st century, when the rest of the world economy struggled, China has been the “growth engine of last resort”. The Chinese state successfully put the foot on the gas and stimulated domestic demand when its export industry suffered from weak demand from abroad. This, in turn, mitigated the economic downturn in the West and helped those countries to recover faster. But now the Chinese economy itself turned sour, and the tools that were used in the past to stimulate growth no longer work. Economists have been conditioned to expect China to come to the rescue rather than exacerbate economic hardships at home. Hence, current forecasts for a soft landing and reacceleration in 2H24 may turn out to be too optimistic.

Since the turn of the century, whenever the rest of the world struggled, China pressed forward. Through aggressive stimulus measures, China bolstered domestic demand to achieve its ambitious growth targets. In turn, this helped western economies in trouble as Chinas demand for their goods didn’t slow. In fact, it often accelerated. This had a mitigating effect on the economic contractions in the West and helped these economies to recover faster.

To be clear, the Chinese economy was certainly not immune to negative outside growth effects. For example, in the early days of the great financial crisis of 2008, Chinese GDP growth slowed down sharply from double digit numbers to “just” 6 percent. But China had the ability to completely decouple from the generational recession that played out in the West. And it did so extremely quickly. By the end of 2009, the European economy was still contracting on a year-over-year basis, and the US economy was barely flat, when China was already growing at 12% again (See exhibit 1). This helped western economies to recover faster as China imported more of their products.

Exhibit 1: The Chinese economy wasn’t immune to outside growth shocks in the past, but it was able to decouple itself from these shocks quickly

%

Source: GoldMoney Research, World Bank

China’s quick return to double digit growth didn’t just help western economies. When commodity prices suffered during the great recession, China filled up its commodity inventories. This helped commodity producing nations and shortened the commodity bear market. Petrostates suffered less, and in turn, demand for western goods from these regions also held up better than they otherwise would have.

This effect is demonstrated in the below chart (see Exhibit 2). It shows growth in the developed economies vs the outperformance of China (China GDP growth – developed economy growth). In a nutshell, when the West needed a boost, China delivered.

Exhibit 2: Since the turn of the century, China provided a boost to the global economy when western economies needed it the most

%

Source: Goldmoney Research, World Bank

Arguably, this no longer held true during Covid. China opted for a more extreme covid policy than the rest of the world and, thus, it took longer for the Chinese economy to recover. However, once China completely ended all Covid measures one and a half years ago, economists expected the Chinese economy to go full steam ahead.

These expectations didn’t materialize. While the Chinese economy managed to grow at double digits rates at some point in 2021, this was simply a base effect from the first lockdowns, as we have seen everywhere else. But since then, the Chinese economy has been just languishing and more recently, outright struggling. Official Chinese economic data must be taken with a pinch of salt. But even that data shows that the Chinese economy slowed down meaningfully. Before Covid, Chinas economy grew at least 6% annually. After the country came to a standstill due to Covid lockdowns and only began to wake up last year. But so far, it hasn’t been able to go back to past growth rates. In 2023, Chinas GDP was expanding by just 5.2%. While, it managed to accelerate to 6.3% in 2Q23, it fell back to just 5,2% in 4Q23.

The most pressing issue is the real estate sector. China experienced several high-profile bankruptcies in the sector of real estate developments in the past year. But it’s not just real estate developers that struggle, the entire sector is in disarray. The China Real Estate Climate Index, a sentiment index published by the China National Bureau of Statistics, shows what can only be described as a crash in the Chinese real estate market (See exhibit 3). 

Exhibit 3: The sentiment in the Chinese real estate market is at the lowest point since the inception of the index

China Real Estate Climate Index

Source: China National Bureau of Statistics

Chinas real estate sector is facing massive structural problems as we look back to two decades of overbuilding. According to data from the World Bank, China added 1250 million square meters of new residential property per year in the ten years up to 2021. This would equate to 125 million new apartments at a size of 100 square meters (according to Bloomberg, the average Chinese home is around 90 square meters). Other sources such as Statista suggest that around 75 million apartments were added over that timeframe. At the same time, Chinas population grew by only 63 million. What makes this even more problematic is that Chinas population peaked in 2021 and is since declining (See Exhibit 4). 

Exhibit 4: Chinas population has peaked in 2021 and is now in outright decline

Million[41] 

Source: National Bureau of Statistics China

For a long time, this didn’t matter for real estate prices as the Chinese were buying real estate for investment purposes rather than as a place to live. Hence, actual housing needs didn’t matter much for demand for newly built properties and, in turn, prices. As a result, a large share of newly built units was never occupied. 

However, it seems that reality has finally caught up with the Chinese real estate market. Reports of entire ghost cities have been circulating for years, but until very recently, this didn’t have much of an impact on the pace of new construction. But now it seems that the bubble is finally bursting. New housing starts are sharply down according to the World Bank (Exhibit 5).

Exhibit 5: New housing starts in China are sharply lower

Million square meters[42] 

Source: World Bank, Goldmoney Research

This creates severe challenges for Beijing. In the past, when the economy hit a snag, China successfully stimulated the economy by boosting the construction sector, both for public construction and housing. But Chinese buyers may simply not be lured back anymore. 

The economic malaise is also reflected in Chinese stock prices. The CSI 300, Chinas main blue-chip index, is down sharply from the highs (see Exhibit 6). While equity prices are not necessarily indicative of the underlying economy, China’s slow stock market crash is in stark contrast to western stock market indices of which many made new highs in the past few weeks. 

Exhibit 6: The Chinese stock market has correctly sharply lower form the highs

CSI 300 Index

Source: Goldmoney Research

This is particularly significant because the Chinese government has rolled out several measures over the past months, not just to stimulate the economy, but to particularly prop up asset prices. The fact that it so far has failed indicates that the underlying economic issues are likely to be severe.

While all the above suggests that China will not come to the rescue should the west need it, so far China economic problems haven’t spilled over to the developed countries just yet. The troubles in the property market are mainly a growth problem as the sector accounts for a large portion of Chinas GDP and employs a lot of people. But we haven’t seen major prices corrections just yet. Real estate prices declined in February for the 8^th straight month. But they are only down 1.4% year-over-year. If prices fall further, we expect Chinese consumption to begin to suffer as well.

The reason lies in the importance of the real estate sector for Chinese household wealth. According to Bloomberg economics, 70% of Chinese family assets are tied up in real estate. Every 5% decline in property prices will wipe out around $2.7tn in household wealth. Because real-estate is such an essential part of Chinese household wealth, it will be very difficult to try to jump-start the economy by stimulating domestic consumption in such an environment. People who feel they are getting poorer don’t want to spend more money on non-investment goods, no matter how much the government tries.

So far, we haven’t seen major spillover effects of the Chinese housing crash onto Chinese demand for foreign goods. However, there are clear signs in some sectors. The most visible area that Chinese buyers are missing is the luxury goods sector. Chinese buyers make up a significant share of the global market for luxury items. For example, according to Statista, China accounted for a larger share of the total luxury watch segment than the next 3 countries combined (See Exhibit 7).

Exhibit 7: China has the largest demand for luxury watches worldwide

$bn

Source: Statista, Goldmoney Research

Prices for Luxury watches on the secondary market declined 25-35% from their peak in 2022 peak according to various price indices. Anecdotal evidence suggests that the bubble in luxury fashion items such as designer handbags, of which some sold for several times their official sales price in the secondary market, is deflating as well. In addition, prices for the most expensive segments of French wines are down sharply from their peak too (See Exhibit 8).

Exhibit 8: French luxury wine prices have been on a declining trend

Liv-ex fine wine 100

Source: Liv-ex

While the global market for luxury items is not large enough to create economic troubles in the producing countries on their own (and more importantly, demand for new items still exceeds supply, allowing these brands to continue to raise prices and sell as much as they choose to produce), it is indicative that the Chinese don’t spend their money as liberally anymore as they have done in the past. If and when this spills over to other sectors has yet to be seen. 

One sector we keep watching is the Chinese automobile sector. Chinese car manufacturers produce close to 30 million units per year. That is about one third of global car production. Should Chinese buyers start shying away for purchasing new cars, the manufacturers would at first push these cars onto the global market, intensifying the competitive pressure for western manufacturers. But ultimately, they would need to reduce output, thus, reducing imports for raw materials. 

February saw a meaningful year-over-year decline in sales. However, it is not unusual to see year-over-year declines in Chinese car sale statistics for one month (see Exhibit 9). This would only start becoming more concerning if we saw several months of declines.

Exhibit 9: Chinese car sales declined year-over-year in February

Million units

Source: China Automotive Tech and Research center, China Association of Automotive manufacturers, Goldmoney Research

In our view, the economic problems of China are far from over. The real estate sector will need to go through a multi-year consolidation phase, and we are worried that the price declines we have seen so far are just the beginning. This is a game changer for the rest of the world, and we think most western economists haven’t fully grasped the implications this has. In the past, Chinas commitment to growth meant that during times of economic slowdown or a recession in the western world, China used to boost their domestic economy, which gave some relief to the export industries in the rest of the world. Particularly the commodity exporting nations benefited from this, but also exporters of industrial goods had at least one region that saw strong growth for their products while exports to neighboring countries declined.

If we enter a global recession now, this Chinese backstop will in all likelihood no longer exist. China would have to find new ways to prop up their economy as the usual lever though the construction sector no longer works, and we believe this will proof very challenging. At the very least, even if they manage to stimulate the domestic economy again, this will not have the same effect on the rest of the world as was the case in the past. At worst, China’s economic woes intensify, just at a time when high interest rates start impacting the US economy while Europe is already on a downward trend.