• China has enough homes for two Chinas
  • Deflation has begun, and it’s unlikely to be the good sort
  • The energy transition versus the China crash

China is the engine of the global economy with the West as its paying for passenger cars. We send China money and it sends us stuff we want. It is, of course, a symbiosis. Our consumption habits fuel China’s economy, but who would you rather be – the producer or the consumer?

History is full of such imbalances, by the way. Economic ideology has answered my question in many different ways over the years.

Sometimes, mercantilism rules and insists that production is the key to prosperity, so a trade surplus defines wealth. In other periods, we focus on how much we can consume and nothing else matters. I mean, if we can print money and buy Chinese stuff, who’s getting the raw deal!?

The confusion over how to perceive trade flows extends itself to policies too. Sometimes countries manipulate their currencies lower to promote exports and sometimes they try for a “strong dollar policy” or to “protect the pound” so that consumers can buy even more. Not only do policymakers not know what they’re doing, they don’t really know why they’re doing it either…

The point is, nobody has a clear answer to the question of prosperity and trade flows. However, we do know that fluctuations in trade matter to investors. We also know that the world’s economic engine is making some funny noises…

It began in August with your usual boring sorts of data misses, as summarised by CNBC:

  • Retail sales rose by 2.5% in July from a year ago, below expectations for a 4.5% increase, according to analysts polled by Reuters.
  • Industrial production rose by 3.7% in July from a year ago, below the 4.4% increase analysts had expected.
  • Fixed asset investment rose by 3.4% for the first seven months of the year from a year ago, below the 3.8% forecast by the Reuters poll.

So far so usual, and not much to get excited about. But then things got weird. Analysts noted that China had stopped breaking down unemployment data by age, as they used to. What were they hiding?

Supposedly the changes to the statistics came because of “economic and social changes” according to the Chinese National Bureau of Statistics. It was reassessing its methodology.

The trouble is, youth unemployment has been growing embarrassingly high. You usually continue to publish data until you change your methodology and begin publishing the new data…

Unemployment wasn’t the only change. We also saw some suspiciously selective data releases. It added monthly retail sales of services, which were up 20.3% from a year ago, for example.

The world’s media began to get suspicious about the data coming out of China. Not only was it mostly bad, it was dodgy. That’s not a good combination.

Then the Chinese real estate crisis entered a new phase, with another major property developer getting into financial trouble, arrests at property developer Evergrande, and concerns about another default from both. More recently, the founder of Evergrande has been put “under police control,” whatever that means.

Real estate is a huge part of China’s economy – about 30% according to one estimate, once you include all the reliant industries. Perhaps more importantly, because Chinese savers cannot easily invest their money outside China, many have ploughed their life’s savings into property, often without leverage. Any property price crash means the destruction of their wealth.

If Dr Copper has anything to say about it, China is definitely sick. Copper demand in China is falling at a time when it usually rises. Because copper is such a ubiquitous metal for so many applications in the economy, it is said to have a PhD in economic forecasting. Falling copper demand suggests falling everything else in the aggregate.

However, with such a large population, surely China’s property crisis is purely an artificial edifice that’ll eventually clear up? Well, this former Chinese official quoted by Reuters suggests that China’s housing supply has gotten slightly out of hand:

“How many vacant homes are there now? Each expert gives a very different number, with the most extreme believing the current number of vacant homes are enough for 3 billion people,” said He Keng, 81, a former deputy head of the statistics bureau.

“That estimate might be a bit much, but 1.4 billion people probably can’t fill them,” He said at a forum in the southern Chinese city Dongguan, according to a video released by the official media China News Service.

Does anyone want to bet on Keng’s chances of surviving the next few weeks?

Contrary to the claims of the Communist Party, the malaise really is spreading beyond housing. The country is in outright deflation, for example. This is enough to give most Western economists a heart attack. For once, I’d agree with them. Because this is unlikely to be the good sort of deflation – when goods get cheaper because of technological advances in production. It’s likely to be the bad sort – panic selling to meet impossibly large debt repayments.

Even more stark is the fact that China is entering into deflation while the rest of the world deals with high inflation. Even more bizarre than that is when you add the context of the nature of the inflation shock, we’ve experienced in the West: producer prices shot up first, and this was then passed on to consumer prices. China, of course, is the manufacturing hub of the world, so you’d think inflation would cause trouble there, especially.

The Guardian’s editorial board summed it all up most elegantly: “The Guardian view on the Chinese economy: it looks bad. What we can’t see may be worse”.

One big question all this poses is why commodity prices haven’t crashed in response. China is, after all, the key importer for many of the world’s resources, with a lot of them going to housing construction. If its building really has slumped 60%, then you’d expect Australia to be exporting convicts and adopting the pound for economic stability.

In answering why commodities haven’t crashed, Bloomberg’s Ye Xie questions the struggling China narrative rather than the commodity prices. He sees China’s property crash being replaced by other sectors of the Chinese economy.

While “The floor space of newly started housing averaged about 87 million square meters over the past 12 months, marking a 60% decline from a peak in 2021”, railway construction, the rollout of solar farms, spending on travel, exports for products like steel and many other sectors of the Chinese economy are going strong.

The impact of the world’s energy transition (which is highly reliant on China’s manufacturing) seems to be offsetting the impact of the property slowdown.

If this is accurate and we have two tsunamis cancelling each other out, the question is which one will win. Lately, the energy transition has been sputtering in Europe and the US. And so China’s struggles may finally get the upper hand when it comes to commodity prices.

The biggest risk is that China’s government’s political legitimacy comes from the results it delivers to its people. Given the powers China’s leaders have, they are actually responsible for the outcomes and can’t blame yesterday’s prime minister. If things get worse in China, we may be looking at a political or geopolitical crisis instead of a financial or economic one.

If the link between the engine and the passenger car breaks, we’re all in trouble.

That’s why China has been a key feature of our analysis in The Fleet Street Letter, Britain’s longest-running financial newsletter. Given that it came to prominence by predicting the outbreak of World War II down to the month, you might want to know what our most recent predictions for China were

Until next time,

Nick Hubble
Editor, Fortune & Freedom