08.17.22 China’s slowing economy has the potential to drag down global inflation and growth. The world’s second-largest economy, weighed down by a property bubble and continual COVID lockdowns, surprised everyone earlier this week by cutting two key lending rates and easing reserve requirements for the nation’s banks – moves intended to bolster sagging economic activity. Policymakers in Beijing face several concerns. COVID lockdowns have stymied economic activity. The most recently reported retail sales, industrial output and business investment data all fell well short of economists’ expectations.  Retail sales expanded a meager 2.7 per cent over the last 12 months but were flat on an inflation-adjusted basis. That’s disappointing for an economy targeted to grow at 5.5 per cent. The jobless rate among 16–24-year-olds spiked to nearly 20 per cent, according to Bloomberg. Where is China headed from here, and what does that mean for the rest of the globe?

Graph 1, Market Update 8.17

China’s other festering problem is its property bubble. For years, policymakers leaned on the property sector to support growth and jobs through credit expansion and land sales. Residential real estate  expenditure in China reached 10.2 per cent of GDP by the end of 2020, compared to 6.2 per cent in the US at the peak of the 2008 housing bubble. Recent attempts to spur residential real estate investment have failed as home prices fell. Housing sales plunged 28 per cent in July and prices have declined for 11 consecutive months, according to Bloomberg. Meanwhile, the middle class, a cohort relied upon to boost domestic demand, is already heavily invested in real estate. The homeownership rate in China is near 70 per cent, with 90 per cent of household financial assets dedicated to real estate. Even though millions of homeowners’ properties are not completed, Chinese rules require buyers to make regular mortgage payments regardless of whether the property is built or not, leaving millions in a financial bind with no solution in sight. Angry purchasers recently circulated an ultimatum letter on social media threatening to boycott mortgage payments until their homes were complete. Chinese authorities usually don’t bend to protesters, but will likely pressure developers to complete their work using state-owned banks for financing. Stripping away the current situation, residential properties are overbuilt and over- leveraged. While the government hopes to cushion the blow for homeowners, residential construction will no longer be the growth lever authorities hope to pull for some time.

Graph 2, Market Update 8.17

China’s weakening demand is also spilling over into the economies of some of the country’s key import partners in Europe and Asia. Sagging imports of manufactured goods, like automobiles, is helping create unusual trade deficits in Germany and South Korea, two export-oriented economies. This couldn’t come at a worse time for Germany, which is grappling with Russian-induced energy shortages heading into the winter. German factory orders have plunged nine per cent over the last 12 months.

Graph 3, Market Update 8.17

When the world’s second-largest economy trips, the rest of the world stumbles. Perhaps it’s a blessing in disguise for countries grappling with commodity shortages and elevated inflation. China’s growth challenges are weighing on global GDP growth expectations. Bloomberg’s global “GDP Tracker Now” anticipates zero per cent year-over-year growth worldwide – that’s remarkable considering the tracker projected growth in excess of five per cent as recently as November. Because China is one of the world’s largest commodity consumers, demand for industrial commodities has plunged: copper is off 27 per cent  since its April peak, and heating oil has also fallen 37 per cent since then. China will eventually recover and contribute to global growth. But in the meantime, China’s economy is injured, and we can’t expect the country to contribute to the kind of growth and demand that we’ve enjoyed historically. Beijing has been quick to point out that its 5.5 per cent annual growth target is guidance, rather than a hard target, conceding that achieving it would be unlikely this year. The recent slowdown has taken even Beijing leadership by surprise. Never in their history have they missed their growth target by such a large margin.