不惜一切代价 (Whatever it takes)

#104 - The Global Stakes of Xi’s ‘Whatever It Takes’ Pledge to Save China’s Economy

Hello friends, I hope you had a great week!

In 2012, the European Central Bank President Mario Draghi famously pledged to do ‘whatever it takes’ to save the Eurozone, a bold move credited with stabilizing Europe. Today, Xi Jinping faces a similar moment as China confronts mounting economic pressures. Once fueled by rapid growth, China’s economy is now grappling with soaring youth unemployment, a teetering real estate sector, and slowing global demand.

Xi’s recent speech reminded me of Draghi’s determination, calling for urgent action to stabilize real estate and hinting at broader interventions to address China’s deepening economic woes. With China’s global economic role, these challenges carry far-reaching implications beyond its borders, and I think these are very relevant for all western economies.

The State of China’s Economy

In the aftermath of the COVID-19 pandemic, China’s growth trajectory has slowed significantly. Once accustomed to double-digit GDP growth, China’s economy is now forecast to grow at a much more modest rate of around 4-5% annually. While this would be considered healthy in most countries, it is far from the breakneck pace China needs to maintain stability in employment and consumption. The gap between official targets and actual performance raises questions about whether Beijing’s central planning is capable of reigniting the economy without resorting to unsustainable debt-fueled growth.

A key driver behind this slowdown is weak domestic demand. Despite government attempts to stimulate consumption, consumer confidence remains low, and household savings rates have risen. Unlike Western economies, where consumer spending has been a key pillar of recovery, Chinese households are reluctant to loosen their purse strings, reflecting a deep-seated uncertainty about the future. Additionally, manufacturing and export sectors are facing increased pressure from slowing global demand, especially as Western economies pivot toward reshoring critical industries and imposing tariffs on Chinese goods.

China’s real estate sector, once 30% of its GDP, is now a major source of instability. Major developers like Evergrande have defaulted on massive debts, shaking public confidence in property as a secure investment. Government interventions have been limited, leaving both banks and homeowners vulnerable as unfinished projects and over-leveraging continue to weigh down the economy.

Perhaps the most striking sign of China’s economic troubles is the record-high youth unemployment rate, which has exceeded 20% in recent months. This is not just an economic problem but a social one as well, with profound implications for China’s long-term stability. The government’s focus on infrastructure and real estate has failed to generate the high-quality jobs that educated youth seek, highlighting deeper structural imbalances.

Local government debt has become a major drag on China’s economy. With years of unchecked borrowing to fund infrastructure, many local governments now face a debt crisis, leading to cuts in essential services. While the central government has been reluctant to bail them out, the risk of defaults and social unrest is growing.

Xi’s Economic Address

In response to mounting economic pressures, Xi Jinping has taken a more vocal stance, particularly regarding the real estate crisis. In September, Xi and top Chinese leaders made a rare public acknowledgment of the struggles facing the real estate sector, calling for urgent action to halt its decline. The President called for stronger intervention to stabilize the market and protect homeowners, signaling that the government may step up with fiscal stimulus and targeted bailouts.

Xi’s rhetoric suggests that the government is ready to take stronger steps to ensure economic stability. His statements emphasized the need to protect homeowners and maintain social harmony—an implicit recognition that the real estate collapse could lead to broader unrest if left unchecked. This is particularly significant because housing has long been a cornerstone of wealth creation for Chinese households, and any further deterioration could have far-reaching consequences for consumer confidence.

China’s export-driven growth, a key strength for decades, now faces unprecedented challenges due to geopolitical tensions and global supply chain disruptions. In response, the government has increased subsidies to key industries, including semiconductors and electric vehicles, aiming to maintain competitiveness. However, this reliance on government support raises questions about long-term sustainability, as these industries remain heavily dependent on global demand and state aid. Growing international competition and protectionist measures, like EU tariffs on Chinese-made EVs, are further squeezing margins.

The Impact on Domestic Demand

The Chinese government’s strategy to bolster internal demand through subsidies and financial support has had mixed results. While the government has successfully sustained some industries and avoided widespread unemployment, the reliance on state intervention has stifled more organic growth in domestic consumption. Chinese consumers, traditionally savers rather than spenders, have not responded to government stimulus efforts as robustly as hoped. Rising property prices, youth unemployment, and general uncertainty about the future have kept consumer spending muted.

This presents a significant challenge for China’s transition to a consumption-driven economy, a transition that Xi Jinping has emphasized as essential for future growth. Despite policies to boost internal demand, consumer confidence remains fragile. For example, many young Chinese are choosing to delay major purchases like homes and cars, given the instability in the job market and housing sector. The central party’s efforts to boost spending—whether through subsidies, tax incentives, or stimulus programs—have not yet succeeded in creating the kind of self-sustaining domestic consumption that could support long-term growth.

Government-Controlled Economy: A Double-Edged Sword

China’s centralized economic model allows for quick intervention in key sectors, but this approach has also created inefficiencies. Fiscal stimulus has been Xi’s main tool to counter the slowdown, but overcapacity in sectors like infrastructure limits its effectiveness. With weak domestic demand and limited monetary options, it remains uncertain whether fiscal measures alone will be enough to steer the economy back on course.

Xi Jinping’s economic strategy carries significant global repercussions. As the second-largest economy, China’s struggles could disrupt supply chains, destabilize financial markets, and escalate geopolitical tensions. Xi’s fiscal measures may provide short-term relief, but it remains uncertain whether they will be enough to address the structural challenges that could lead to a broader crisis. The outcome of Xi’s ‘whatever it takes’ moment will shape the global economy for years to come.

Global Supply Chains: A Critical Link

China’s role as a global manufacturing powerhouse makes it a linchpin in supply chains across industries, from electronics and semiconductors to consumer goods and automotive parts. The slowdown in Chinese production and the challenges in key sectors like real estate and manufacturing are already creating disruptions. If China’s economy were to face a more severe downturn, the impact on global supply chains would be profound.

The global chip industry is a prime example of this interconnectedness. China is a major player in the production and consumption of semiconductors, and any further disruptions in its ability to produce or source chips could exacerbate the global chip shortage. This would not only affect technology companies but also industries like automotive manufacturing, where chips are crucial components. As countries like the U.S. and those in Europe attempt to decouple from Chinese supply chains, the resulting disruptions could lead to inflationary pressures and slower economic growth worldwide.

Export-Driven Economies at Risk

Many countries, especially in Asia, are heavily reliant on exports to China. Countries like South Korea, Japan, and Australia count China as their largest trading partner, and any significant slowdown in Chinese demand would have a direct impact on their economies. A contraction in China’s manufacturing output or a prolonged real estate crisis could lead to reduced demand for commodities like iron ore, copper, and coal, which are critical to countries like Australia and Brazil.

Even Western economies, particularly in Europe, would feel the impact. Germany, for example, has significant exposure to China, particularly in the automotive sector. The slowdown in China’s consumption of German cars and machinery is already hurting Europe’s largest economy at a time when it is already facing its own inflationary environment challenges.

Financial Markets and Global Investment

China’s real estate sector is a major source of risk for global financial markets. The massive debts incurred by Chinese property developers have been financed in part by foreign investors, and defaults by companies like Evergrande and Country Garden have already sent shockwaves through international bond markets. If more developers default or if the Chinese government is forced to intervene in a larger way, the ripple effects will be felt globally.

Global investors are heavily exposed to Chinese equities and bonds. A deeper downturn in China would likely trigger capital flight, as international investors seek to reduce their exposure to Chinese markets. This could lead to a sell-off in emerging market assets more broadly, creating financial instability in countries that rely on foreign capital flows. The knock-on effects of such instability could spread to global stock markets, as investors flee riskier assets in search of safe havens.

Geopolitical Tensions: The Risk of Escalation

The economic struggles China is facing also have profound geopolitical implications. As China’s economic strength falters, its leadership may feel pressured to take a more assertive stance on the global stage to project power and maintain domestic legitimacy. This could exacerbate tensions with the United States and its allies, particularly in areas like trade, technology, and territorial disputes in the South China Sea and Taiwan.

The ongoing U.S.-China trade war and the broader decoupling of the world’s two largest economies are already creating uncertainty for global businesses. As China seeks to defend its economic interests, it may double down on policies aimed at protecting its strategic industries, such as semiconductors and electric vehicles, which could lead to further escalation in the tech war. Moreover, the geopolitical rivalry between China and the West is playing out not only in trade but also in diplomacy and military posturing, particularly in Asia and Africa, where China has invested heavily in infrastructure projects through its Belt and Road Initiative.

A prolonged Chinese economic crisis could also lead to increased nationalism and social unrest within China, potentially pushing the government to focus even more on external enemies to unify the country. This could heighten the risks of conflict, particularly in areas where China has territorial claims, such as Taiwan or disputed waters in the South China Sea. Such conflicts could have catastrophic consequences for global trade routes, particularly those that are vital for energy supplies and shipping.

Risks of a Hard Landing: Social and Economic Fallout

Internally, the Chinese government is deeply aware of the risks of a hard landing—a situation where the economy experiences a sharp and severe downturn. The social consequences of such a scenario would be dire, especially given the high levels of youth unemployment and the public’s declining trust in the real estate market. With the Chinese middle class having much of its wealth tied up in property, a further decline in housing prices or widespread defaults on mortgages could lead to social unrest.

This is a critical concern for the Chinese Communist Party, which views stability as its primary mandate. Any economic mismanagement that leads to significant social disruption could threaten the CCP’s hold on power. The Party’s legitimacy has long been tied to its ability to deliver economic prosperity, and a deepening crisis could trigger more vocal discontent, particularly among the urban middle class and younger generations who feel left behind by the current economic system.

Can Xi Jinping Achieve a “Draghi Moment”?

The question of whether Xi Jinping can pull off a “Draghi move” is ultimately a question of whether the tools at his disposal are enough to stabilize China’s economy and prevent a broader global crisis. Xi’s interventionist policies, while effective in the short term, may not be sufficient to address the underlying structural issues that China faces.

The global stakes are high. If China fails to engineer a recovery, the consequences will be felt around the world, from disrupted supply chains and weakened commodity demand to heightened geopolitical tensions and financial market instability. While Xi’s commitment to doing “whatever it takes” is clear, the complexity of the challenges China faces makes it uncertain whether his policies will be enough to prevent a more severe economic downturn with global repercussions.

Wish you a fantastic weekend,
Giovanni