An Update On That China Situation...

Earlier this month, China officially slipped into deflation, providing another signal that all is not well with the world's second-largest economy.

Since coming out of lockdown, China has struggled to realize the economic growth that was anticipated by so many. Now, right at the time when the state needs a win, it's seeing anything but the prosperity that its citizens tacitly expect in return for sacrificing their freedoms. Unfortunately, the government has limited options.

State Of The Nation

Articles about the difficulties China is facing are now a staple of the day's economic news. There are several significant and interlocking issues that defy easy solutions. After decades of double-digit GDP growth, the chickens are coming home to roost. Economist Paul Krugman diagnoses the root problem as follows:

"The basic point is that China, in various ways, suppresses private consumption, leaving the country with huge savings that need to be invested somehow. This wasn’t too hard 15 or 20 years ago, when Chinese G.D.P. could grow as much as 10 percent a year largely by catching up with Western technology: A rapidly growing economy can make good use of huge amounts of capital. But as China has grown richer, the scope for rapid productivity gains has narrowed, while the working-age population has stopped increasing and has begun to decline."

The additional kick given to it by COVID and the policies surrounding it has left the Chinese economy in a tough position. Picking a few statistics out of the bag:

• Private investment is down by two-thirds since Q1 2015, and by 25% since the start of 2020.
• The Hang Seng stock index is in bear market territory, 20% down from its January high.
• The yuan is at a 16-year low.
• The real estate market is faltering as the government seeks to deleverage it. Country Garden, at one time the country’s largest developer by property sales, has missed payments on two US dollar bonds.
• Effects are spilling over to the vast shadow banking sector. Recently Zhongrong Trust, an investment trust that manages $87 billion for corporate and high net worth clients, missed $19 million in payments on over 30 wealth management products.
• Local government debt has soared to almost $13 trillion, or three-quarters of economic output.
• Youth unemployment is running above 20%.

What Could The Wider Effects Be?

As the world's second-largest economy, the fear is that a slowdown in China could have serious effects for other countries. China could effectively export deflation to the countries it trades with, as prices fall, potentially pushing them towards recession too.

But it's not all over. China has some big levers left to pull, after all, and it's far more concerned about its own economy than the rest of the world.

Krugman argues that China's economic problems would largely be confined to its own borders, with relatively little contagion to the US or other major economies (due to the low level of foreign investment in China, and low levels of exports to China). However, there are bound to be some effects, especially for the sensitive crypto markets.

Back in 2015, China devalued the yuan by 3% over just two days, in a surprise move designed to help boost exports and as part of a wider package of reforms. Bitcoin crashed by more than 20% over the next two weeks, severely undermining the nascent crypto market recovery.

PBOC has been supporting the currency in recent days, selling dollars to prop up the yuan. Some analysts are now suggesting it might instead opt for another significant devaluation later this year, just like it did 8 years ago—with all that means for the strength of the dollar, and for BTC.

History doesn't repeat, but it might well rhyme.

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