WTF is going on with the Economy?! #118 - Whats been happening with China?
Europe’s economic performance and the interest rate question
This morning, European governments and the EU Statistics agency began releasing numbers for the eurozone’s performance during the fourth quarter of 2023. How did the economy finish off the year? It depends on where you’re looking.
Overall, analysts believe that the European economy as a whole will avoid a mild recession, with GDP staying at 0%. However, not all countries performed equally.
The French and Italian economies came in flat, defying a recession but failing to grow. Germany meanwhile saw a small contraction (-0.3%) as it continues to struggle with a changing global economic landscape. Spain on the other hand beat expectations, recording the best growth in the bloc at 0.6% for a total of 2.5% GDP gains in a year.
Why are these numbers important?
Central bankers are watching these data closely. Their job is to manage both economic growth and inflation with interest rates as their main tool to do so.
The logic behind interest rates is that when the economy gets too hot, central bankers can raise rates to make it more expensive to borrow money, and more attractive to leave it in a bank. In turn, companies and individuals borrow and spend less, which cools economic activity. Conversely, if the economy needs a boost, central bankers will cut rates to make it cheaper to borrow and spend.
Both inflation and interest rates shot up during the past two years. Now, with the EU economy cooling, all eyes are on the European Central Bank, watching for the signs of an interest rate cut. Last Thursday, the Bank stated that it’s too soon to start discussing cuts. Instead, it prefers to keep rates where they are at 4% until inflation looks like it’s subdued. This task is easier said than done. Slowing economies need lower interest rates to prevent deep recessions or even longer term stagnation. But with economic growth coming in at different speeds, getting the time right will be crucial, especially since some economies like Spain are still growing (with inflation rebounding there as well).
For now, we’ll have to wait and see, as the central bankers hope factors outside of their control break their way.
What’s been happening with China?
Seeing as it’s the second-largest one in the world, we periodically like to check into what’s happening with China’s economy. As it’s been a while since our last look we thought it’d be a great time to revisit it.
A long economic slowdown
Starting in the early 1980s, the Chinese economy went through a massive transformation, with annual growth never dropping below 6%. However, the pandemic put a halt to that streak, and like with other countries, its economy shrank as harsh lockdowns stifled growth.
Analysts at the time believed that China’s economy would rebound once the lockdowns ended and then resume its seemingly unstoppable growth streak. After all, most other economies had similar experiences following the outbreak of the pandemic, and it seemed logical that China would follow the same trajectory.
Unfortunately, that wasn’t the case. The pandemic hit the Chinese economy at an inopportune time. In the run-up to 2020, economic growth had been steadily declining since the early 2010s. Throughout the ensuing decade, the economy hit a few bumpy patches, including a stock market and real estate crash that forced the central bank to spend one trillion USD from its reserves to stabilize it.
Since the pandemic wound down, the economy has failed to find its footing. Chinese stock markets started 2024 continuing their slump started in 2021. High youth unemployment and an aging population are weighing down growth. At the same time, household, real estate and corporate debt continue to grow, running the real risk of a looming balance sheet recession.
(Both Japan and the EU went through a balance sheet recession in recent decades. In short, these happen when companies and people have too much debt, and instead of spending money, they take their savings and income to pay back loans. When they do it at the same time, it slows economic growth).
Evergrande is ever gone (and maybe more is on the way)
Yesterday, a court in Hong Kong sealed the fate of China’s largest property developer and most indebted companies. China Evergrande spent years raising money and building massive property developments. Economists and analysts attribute its rise in popularity to two phenomenon:
- Chinese companies and consumers had excess savings that needed to go somewhere other than in a bank account.
- Culturally, real estate is the preferred investment in China.
These two factors provided Evergrande and other developers with abundant capital. Yet, it’s widely seen that these firms grew too fast, building apartment blocks and even entire cities without corresponding demand. When China’s economy began cooling and with consumers weary of draconian lockdowns (preferring to save money instead of invest it), the funding dried up.
Already in 2021, Evergrande missed its first loan repayment (at the time, they had a whopping 328 billion USD in liabilities). The company tried to both work with its creditors and raise more capital on the market. By late last year, its debt obligations rose to over a half trillion USD.
By late last week, the company was out of options. Despite trying to strike a last minute deal with its creditors, a judge in Hong Kong ordered the company to liquidate and go into administration. Analysts, investors, and the Chinese government are all nervously watching what happens next. The best case scenario is that Evergrande is a one-off case. The worst? The dominos start to fall and the entire sector collapses. In that case, tens if not hundreds of millions of Chinese investors will be left holding the bag on unfinished properties, while the government spends reserves to rescue the economy.
The growth and export dilemma the world is watching
These factors aren’t happening in a bubble. In fact, China’s economy is more entrenched than ever in economies around the globe. Consider that China is a major manufacturer, exporter and importer.
Even with globalization getting re-racked, China is still the world’s preeminent factory and exports to countries around the world. It’s also a massive importer of high tech products and knowledge from other countries.
In normal times, when global growth cooled, it could divert excess manufacturing to domestic consumers who supported demand. Likewise, manufacturers in developed countries counted on the Chinese market to expand business and counteract the impacts of their own slowing economies. This relationship acted as a hedge of sorts for both economies.
Now, that ‘insurance’ has disappeared. Due to the changing economic conditions in China, neither local nor foreign manufacturers can count on the domestic Chinese economy to boost sales and growth. For export-driven economies like Germany and Italy, this contraction couldn’t have come at a worse time as Europe’s economy has effectively stopped growing. Conversely, with Europeans spending less, China is manufacturing and exporting fewer goods to the continent, creating a dangerous spiral for both economies.
What can be done about this situation to stop the downward spin? The Chinese government is already aware of the risks they face, as Japan went through an eerily-similar situation at the end of the 1980s. To that, leaders are ready to invest into the economy to prop it up and get growth moving upwards again.
European governments are also trying to act. The NextGen EU fund worth 800 billion EUR came out of the pandemic with the goal of boosting growth. So far, only a small part of these funds have been deployed. Depending on how governments in Beijing, Brussels, and beyond act, will determine the next steps. Finger’s crossed that they’ll get it right.