No, China’s economy is not collapsing, as so many finance YouTubers are claiming.
I mean YouTube was filled with these kind of thumbnails. And, so, I decided to click on one.
<Clip Business Basics: “China is crumbling”>
Okay, damn, that was intense, so, I clicked another,
<Clip Casgains Academy: “Economists worldwide know that the China’s recent social unrest is a signal of the complete disintegration of the Chinese economy”>
<Clip Graham Stephan “this could quite literally lead China to the edge of the next great depression in a very short amount of time>
And a very short amount of time is apparently 29, 28, 27, 25, days…. Wow, clickbait is king I guess. And,
Sure, China seems to be in big trouble with a massive real-estate crisis, bank-runs, harsh Covid-lockdowns, capital flight, and a growth model that has quite literally run out of steam.
But, in my humble opinion, the clickbaity “complete collapse” or “great depression” scenario is extremely unlikely for two reasons.
First, China’s political system is nothing like the U.S. when it entered the Great Depression. Second, China’s economy is nothing like those of Asian economies that are actually collapsing, such as Sri-Lanka.
So, let’s get into these two differences.
Argument 1: China ≠ USA
Sure, at first sight, China’s situation seems an awful lot like the collapse of U.S. banking system in the early 1930s and in 2008.
So, Let’s have a look at how China’s current situation compares to these two dramatic events.
The story of the Great depression starts with epic growth of bank lending as well as a massive increase in asset prices, mainly in the stock market. In a similar way, the story of the great recession starts with epic credit growth paired with huge asset price increases, mainly in property AND the stock market.
So far, this is extremely similar to China’s story.
This ended up making Chinese cities like Shenzen and Shanghai 4x more expensive relative to income than a city like New York in 2020.
So far, so similar.
And, clearly, asset prices, compared to the size of the economy, cannot rise forever.
So, asset prices had to come down at some point in all three cases. Then, in all three cases, banks that made loans backed by these assets started to fail. Unsure of whether their money was safe or not, people started to demand their money back from the banks.
And, in any modern banking system, all people wanting their money at the same time is not possible.
So, in all three cases, people wanted to be the first to get their money out of the banking system, sparking a bank run. This is where China is now and, this is also where the stories of the great recession and great depression started to diverge.
You see, at the start of the great depression, the U.S. central bank basically let the banking system collapse.
And let’s be honest, for any normal business that gets into trouble, it makes total sense that the government just lets it collapse.
The problem is that as a system, banks facilitate both payments and credit creation for the entire economy. So, letting them go bust is a bit like letting all your electricity companies go bust at the same time.
It might be justified from a moral perspective.
But, you kill your entire economy in the process.
In the case of the U.S., it took a decade for the economy to recover.
However, in 2008, after seeing the damage done by the collapse of the Lehman brothers bank, the Federal Reserve bank did end up rescuing the financial system.
the Federal Reserve bank did end up rescuing the financial system.
Again, not fair to let bankers get away with blowing a bubble.
But, the US did manage to avoid another great depression and ended up with the milder great recession.
And this where you will find out why China’s story is different from the great depression as well as the great recession.
You see, just like with the great recession, China’s central bank is well aware of the dangers of letting the credit and monetary system of your economy collapse for the sake of teaching people a lesson.
What’s more, China’s story now is different from that of the great recession in two other important ways.
First, its banking system is already for the most part state owned. So, a run, to get paper money from these banks would be short-lived, since China’s central bank can easily provide it. Second, unlike the U.S. politicians, who waited till the bubble to collapse on its own, the Chinese bubble was popped by the government itself. Specifically, when it implemented its three red line’s policy which required ‘bad’ property developers to start deleveraging.
So, in summary, China’s economy will not collapse in a U.S. style great depression because China’s central bank has learned the most important lesson from the U.S. great depression. Yes, reckless behaviour should be punished. But, not by crashing your entire economy. What’s more, I think China’s crisis will not be as severe as the great recession. The reason is that China’s government values stability more than the U.S. government. So, I suspect it will try to spend its way out of trouble more forcefully.
But, then again, at this point you might say that you cannot compare China to the United States because the U.S. issues the global reserve currency. It has more room to spend its way out of trouble because it is basically funded by foreign countries that desperately need Dollars.
And, one key feature of China’s current problems is that international investors seem to be fleeing the country in droves.
So, maybe it shouldn’t be compared to the U.S. but rather to other Asian economies that are currently collapsing in an inflationary death spiral, such as Sri-Lanka.
Well, no, and here’s why
Argument 2: China ≠ Sri Lanka
The reason why China can save it its banking system if it wants to is that, unlike Sri-Lanka, China has achieved monetary independence. And, it has achieved this in two ways.
The first way was by becoming a manufacturing superpower.
I mean, by the latest calculations, it accounts for 1/5th of the world’s manufacturing output.
Therefore, it is not surprising that, China has consistently run a trade surplus with the rest of the world.
In other words, the world needs China’s products. Therefore, even though it doesn’t issue the reserve currency, it’s central bank has plenty of Dollars, to spend.
And, it will likely spend these to defend the currency and easily offset the effect of fleeing international investors.
This will help it avoid a Sri-Lanka style collapse.
But, then again, as we saw in February, when the Russian Rubel absolutely collapsed, a trade surplus alone is not enough.
Russia’s problem at the time was that while many Dollars were coming into central bank coffers via exports, Russian citizens were rushing to get even more money out of the country.
This was the same for Turkey, where, people don’t trust the government and thus dumped Lira’s to buy gold, crypto, and dollars.
And this brings us to the second way in which China has achieved monetary independence; and that is capital controls.
You see, capital controls basically mean that you make it extremely difficult for money to cross borders. And, in China’s case, it is notoriously difficult to get money out of China as the Chinese government prevents people from taking money out of the country.
This is the same type of policy that Russia started implementing in response to Western sanctions. And this clearly helped Russia rescue its currency and avoid a Sri-Lanka style collapse.
And the combination of this and the trade surplus, means that, just like the United States.,
China has the monetary independence to create as much of its own currency as it wants, to rescue its banking system.
Making a complete collapse extremely unlikely.
But, all of that being said, China is still in big trouble.
In absolute size, its property bubble is the biggest the world has ever seen. And, while it is popping the bubble itself, the government has simultaneously hurt its economy in three other main ways.
First, it’s one child policy from the past, now means that it is facing a rapid population decline in the coming decades. More immediately, it is preventing its consumers from spending more by keeping them locked up inside in response to Omicron. Finally, it is cracking down on its relatively productive tech and education industries, and the private sector in general.
But, since it has achieved monetary independence and likely learned the lessons from the U.S. great depression, I just don’t think it will crumble,
No matter how many sensationalist YouTubers will try to tell you the opposite.
Instead, I think a short recession, followed by a major government intervention, and then a long period of stagnation or slow decline, like Japan, is the most likely scenario.
But, hey, I’m deliberately saying scenario. You see in macroeconomics, just like in politics, I think it is helpful to think in scenario’s and give these a probability.
In my mind the “sensationalist YouTuber collapse scenario” is just as likely as throwing two dice and hitting double six. It’s possible. But, highly unlikely, given Xi’s focus on social stability and China’s monetary independence.
On the other hand, I think that a sustainable economic recovery is like hitting double five, double four, OR, double three. More likely. But, still, unlikely.
Finally, all other combinations of the dice represent a Japan style stagnation scenario.
But, what do you think, how likely do you think that each of these scenarios is? Either let me know in the comments, or discuss it more in depth with Money & Macro members, Patrons and myself in my Discord sever.
In any case, I will keep covering the situation as it unfolds, so make sure to subscribe. And, if you want to know more about the Japan style scenario, check out this video over here or if you want to know more about the global economy’s debt problem, check out this interview over here.