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Will China Bite the Bullet or the Dust?


A month after Moody’s lowered the outlook on its AAA rating on US government debt from “stable” to negative, it did the same to its A1 rating on Chinese government debt this week.

More interesting than Moody’s decision was the reaction from Beijing that was surprisingly restrained.

The Chinese Ministry of Finance only expressed disappointment while a foreign ministry spokesperson said China is capable of deepening reform and addressing its challenges and welcomed "friends" from "all over the world" to invest in China.

Is it possible that China is finally acknowledging that there is a problem? If so, should we see this as a negative or a positive sign? What does China have to do to steer its economy away from the brink of disaster?


The Chinese state media has been taking a new tone towards the US lately, with less negative coverage, calls for a return to warmer ties and stories of Americans with positive connections to the country.

Stories such as a recent trip by members of the Philadelphia orchestra to mark the 50th anniversary of its 1973 trip to China that helped build then-fledgling U.S.-China ties.

Or the visit by members of the Flying Tigers, a group of American military pilots who helped China fight Japan in World War II.

On the eve of President Xi Jinping’s trip to the US last month, the Peoples’ Daily wrote that “The Chinese people will never forget an old friend, and that’s an important message we want to send to the American people.” (Chart 1)

Even Xi’s sudden decision to travel to the US took many people by surprise, especially given in the weeks leading to his decision Washington had widened the sanctions on the export of AI chips to China (Chart 2) and approved the first-ever military aid to Taiwan. (Chart 3)

In the US, Xi agreed to restore the military hotline between the two countries that China cut off last year in protest of the Pelosi visit to Taiwan. He also agreed to directly target companies that are producing precursor chemicals for the production of fentanyl that Washington wants to stop coming into the US.

It was not clear what Xi got in return, but that did not stop the usually confrontational Global Times to call it a strategic, historic and directional summit. (Chart 4)

Are US-China relations improving?

I don’t know but what I do know is that China has decided to play nice.

I am not sure why but I suspect it may have something to do with the Chinese economy.

I suspect the Chinese leadership has finally realized the depth of the economic crisis at hand.

I suspect the Chinese leadership has decided that at least at this moment in time, China needs the US more than the other way round.


A symptom of both China’s economic troubles and worsening US-China relations is a dramatic deterioration of China’s net direct foreign investment balance (Chart 5).

Foreign firms pulled more than $160 billion in retained earnings from China during six successive quarters through the end of September. (Chart 5)

Meanwhile, Chinese’s share of the biggest market for its exports c0ntinues to shrink. (Chart 6)

US imports from China is now less than 14% of total US imports, the lowest level in nearly 20 years (Chart 6)

And it is not only the US where Chinese exporters are seeing reduced demand. (Chart 7)

Chinese exports to Europe and even to south east Asia have fallen by 15% over the past year (Chart 7)

The decline in Chinese exports over the past year is not as severe as what happened in 2008-9, but then the world is not in a recession like was then. (Chart 8)

China is still the world’s largest exporter and its exports got a big boost during the lockdown but its market share in global trade is sliding back (Chart 9).

Walmart, the world’s largest retailer, imported 60% of its foreign produced goods sold from China in the first eight months of this year, down from 80% for the same period in 2018. (Chart 10)

In contrast, 20% of Walmart’s imports came from India, up from 2% in 2018. (Chart 10)

Slowing demand for Chinese goods is weighing on Chinese manufacturing and growth more generally.

China’s purchasing managers’ survey for the manufacturing industry shows that over the past year, export orders have been contracting much faster than domestic orders (Chart 11).

I am tempted to think that China’s softening tone in its dealing with the US is calculated to slow down foreign capital outflows and the relocation of global supply chains.

It is unlikely to be a coincidence that China held its first ever international supply chain expo two weeks after Xi got back from the US. (Chart 12)

China’s specular economic growth over the past 20 years had a lot to do with its ability to sustain faster export growth than global trade growth.

With exports still accounting for 20% of Chinese GDP and average annual global trade growth at just 2%, China cannot afford to lose its global market share if it is to maintain 4-5% GDP growth over the next 10 years. (Chart 13)

I suspect this was why Xi decided to swallow his pride and went to the US to buy time.

He needs a time-out with the US to focus on the problems at home, problems that he could no longer pretend will go away by themselves.


The fact that lockdown has been lifted for nearly a year and Chinese consumer confidence remains at a 20-year low has to be making Xi Jinping very nervous.

I know I would be if I were in his shoes.

Forget about what depressed consumer confidence says about the public approval of his job performance, depressed consumer confidence is causing Chinese consumers to sit on their vast savings as opposed to spend (Chart 15)

Slowing retail sales over the past six months bears out this hesitancy clearly (Chart 16)

The fact that visits by Chinese tourists to sunny and welcoming Thailand are barely one quarter of where they were before the lockdown says that Chinese demand for services is not much stronger than for goods. (Chart 17)

China is facing both weak foreign and domestic demand.

In the past when China faced weak foreign demand, it was always able to simulate domestic demand to compensate.

This time stimulus has been less effective.

For example, despite mortgage rates are at an all-time low (Chart 18), demand for mortgages has collapsed.

Incredibly, total household mortgages have not gone up in the last 20 months (Chart 19).

Why is stimulus not working?

What is the bottleneck?


Everyone knows that the Chinese housing market is in big trouble.

But with minimum down payment requirements of 20% for first-home buyers and 30% for second-home buyers, the main risk associated with China’s housing crisis is not widespread mortgage defaults like we saw in the US during the housing crisis of 2008-9.

Yes, China’s housing crisis is not about the ability or willingness of Chinese homeowners to service their mortgages.

China’s housing crisis is about the solvency and creditworthiness of Chinese property developers

As you probably know, China Evergrande, once China’s largest developer and with 300 billion dollars of outstanding debt, defaulted in 2021.

Since then, 46 other developers have defaulted.

China Evergrande spent the past two years trying to restructure its debt with creditors and it has been unsuccessful so far.

Meanwhile, Evergrande’s problems are getting bigger with everyday that passes.

A new auditor said in July that Evergrande had lost a combined $81 billion in 2021 and 2022. That compared with what the company said in 2020 was a profit of $1 billion.

There has been a lot of talk about accounting irregularities, fraud, and weakness of China’s corporate governance system.

But fixing the governance system is not going to fix China’s housing problem right now.

To fix the housing problem, we need a quick solution for Evergrande and other troubled developers that have become the bottleneck for the entire Chinese economy.

Bottleneck because these developers can no longer access liquidity

In other words, nobody would lend them any more money

And without money they cannot complete the apartment buildings that they started building

Nomura Securities recently estimated that there are 20 million units of such apartments right now

While they are sitting on millions of unfinished apartments that produce no income, their debt is still growing from unpaid interests.

Meanwhile, many people who bought one of these unfinished apartments are in a serious bind, with no recourse to recover their life’s savings.

People who want to buy a home are hesitant to buy pre-sold apartments.

This makes it very difficult for developers to raise money for new projects.

As a result, home sales are down 50% from 2021 and housing starts even more. (Chart 20)

Even with fewer new buildings completed, prices of new residential buildings are still falling (Chart 21)

I can go on, but you got the point.

The entire housing market is stuck.

At its peak, the Chinese housing market was contributing about 20 to 25% of GDP.

Evergrande and other troubled developers have become the biggest drag on the Chinese economy.

It is shocking that Beijing has lost so much precious time by allowing Evergrande so much leeway to find a way out on its own.

But recent developments suggest Xi Jinping may be ready to bite the bullet.


Time is money.

I can understand why Beijing has been relying on the market to find a solution to the trouble developers.

But market solutions are not necessarily the best solution in this situation.

The creditors of China Evergrande are demanding a liquidation of the company.

But unfinished apartments are not easy to sell. Liquidation would mean a fire sale that could shake confidence further in the property market.

I can understand the desire to punish the owners and management of these developers.

But justice is a luxury that the China cannot afford right now.

I can also understand why Beijing does not want to bail out the foreign creditors of the developers, but in a crisis you do what you have to do and not what you want to do.

There are signs in recent weeks that Xi Jinping and his team are moving in a new direction.

There are reports that Beijing is demanding state owned banks to provide unsecure loans to a list of 50 developers to complete their unfinished apartments.

The same reports suggest that Beijing has agreed to not hold the banks responsible if they cannot recover the loans later on.

The implication is that Beijing will inject more capital into the banks if it becomes necessary later on.

I see this as targeted fiscal stimulus that is designed to unlock the frozen housing market.

In my judgment, this is a pragmatic move in the right direction.

Let’s just hope it is not too late.

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Dec 09, 2023

Do you think the targeted stimulus will work? WIll China be able to recover its old growth trajectory at least for next year? Seems like no one has any confidence in China right is hated...and depressed...

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I think Chinese construction activities will pick up as developers get funding to complete the unfinished apartments. This is a pre-condition for recovery of the rest of the economy.


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