Weak Domestic Demand

Another weak economic report from China, where prices are hovering near deflation.

Since late September, Beijing has ramped up stimulus announcements in a bid to prop up the faltering economy, including several interest rate cuts and loosened property purchase rules. On the fiscal front, the finance ministry unveiled a five-year 10 trillion yuan ($1.4 trillion) program in November to tackle local government debt problems.

Still, the latest economic data out of China have underscored persisting deflationary pressures in the flagging economy.

The continued deterioration of China's economy can no longer be papered over. Real estate is collapsing, and yet overall economic growth is said to be around 5%.

Real estate was once a major driver of the economy, and the significant reduction in economic activity in that sector most certainly should be reflected in the national numbers, as there is no obvious replacement. We know that at least some of the real estate numbers that contributed to growth in past years were simply not real, as well. Yet the numbers are not revised and past growth is assumed.

We've seen huge companies and even industries regulated to death, with no change in the overall growth rate.

Consider: China's labor force is shrinking, and its labor participation rate is falling. Yet somehow the overall pie is still getting bigger at 5%.

At some point the fascination with growth numbers must be abandoned. Growth doesn't ensure improvement in people's lives. Lower growth is not a negative at all, from CNBC:

Ultimately, “the fact remains that growth of even around 3% would not be, by any stretch of the imagination, a disaster for the Chinese economy,” Darren Tay, head of Asia country risk at BMI Country Risk & Industry Analysis told CNBC.

“If they would continue to grow at that pace, which probably would be more sustainable, the average Chinese citizen would be in real terms, better off in income by 13% by 2033,” he added. “So living standards would still continue to rise."

Business Insider ends up soft-selling this very persistent problem as a basic problem of calculation, in an otherwise excellent article:

While there have been long-standing doubts over the veracity of China's GDP data, one economist explained to Business Insider in 2022 that the headline GDP figure is "systematically inflated" due to how it's calculated and that it's unlikely the central government in Beijing manipulates numbers.

Chinese media implicitly recognizes current economic conditions, using 'recovery' regularly in headlines that spin positivity, but you can't have a recovery until a bottom is reached.

I remember from my MBA studies that when you goose up your profits, you end up way over your skis down the line, and that is certainly where we are here.

The government support in September and October did what it presumably was supposed to do, bring the stock market back in order to avoid an embarrassing yearly result. This sop to the markets was always only going to provide a small bounce, because none of the fundamentals are altered. And, with these new numbers out, markets are already cooling off again.

Economic growth does rise and fall, by which forces we only can speculate. A 5% goal which must be attained year after year is simply impossible: If we marshal true economic growth up to 5% annually, we will more than likely see 5.5% or 6% the year after, along with inflation, causing new problems. Economic growth does not happen linearly.

Productive forces grow bigger and stronger, but they may not grow consistently. They may grow quickly at earlier stages, but they also may shrink and reduce later, as business conditions and broader economic conditions change. Productive forces grow in conditions of stability. Uncertainty makes business success much harder, whether that uncertainty is about prices, regulations, or labor availability.

We are left with the conclusion that China has significant excess labor, which dovetails with the economic uncertainty that seems to hover over market participants. Only raising exports can match the size of the labor market displaced by the construction market. Indeed, China is eager to increase exports, and must push up the value chain wherever possible. Still, given the reality of the incoming Trump Administration and E.U. concerns about dumping and labor abuses, China will not be able to create sufficient new jobs in the export market.

So once again we are left considering domestic demand. The willingness and ability of consumers to spend on goods and services.

The government program to subsidize purchases of home appliances is just the kind of program that impacts this group of workers displaced by the reduction in construction.

The cash-for-clunkers and appliance recycling programs have helped keep factories humming, as has President Xi Jinping's emphasis on building up high-tech industries for “high-quality” development. That has supported manufacturing: growth in factory output ticked up to 5.4% year-on-year from 5.3% in October.

Further progress in this area could be implemented by creating a warranty and repair network, in order to sop up more of this labor. Additional labor reforms could include tax cuts, or government supports for healthcare or home purchases.

Labor reform is increasingly necessary to meet the challenges of today. Due to the Hukou system, workers are still often unable to build up residency and create a new home for themselves. A significant portion of China's labor force is therefore pulled between their work and their family. Every year the factories must hire and train their new staff, which certainly makes it difficult to improve labor productivity.

Allowing workers to live in the cities where they work long-term would also help local real estate markets. Furthermore, the emotional cost of leaving your family to seek out work in far-flung places means that workers may decide simply to not join the labor force at all. This impedes corporate planning and could create dislocations between factory expectations and the reality of available workers.

Still, there is no clear way forward at present. The outlook for 2025 is not excellent.