China's economy is in trouble: What does that mean for the U.S.?

The East Asian superpower's struggles to recover from the pandemic could have huge consequences.

A man walks on an overpass near a construction site with tall buildings in the background.
A man walks on an overpass near a construction site of a subway station in Beijing, China, April 18. (Tingshu Wang/Reuters)

As China struggles to emerge from the economic catastrophe caused by the coronavirus pandemic, its continued efforts seem to have stalled on a number of fronts, as debts mount and consumers show renewed caution about spending.

And as the recovery falters, a moment of truth looms, with potentially enormous consequences for the United States.

Because the economies of the U.S. and China are so deeply connected, policymakers in Washington and finance titans in New York are closely following Beijing’s response to what could be a temporary setback — or a widening crisis with global implications.

And even as diplomatic links between the two nations fray, business ties persist. Elon Musk of Twitter and Tesla, Jamie Dimon of JPMorgan and Tim Cook of Apple have all recently visited China, in what could be seen as an attempt at reassurance.

“Let’s not try to hurt China, the Chinese people,” Dimon said during last week’s visit. “You’re not going to fix these things if you are just sitting across the Pacific yelling at each other.”

Much slower growth

Chinese President Xi Jinping sits next to a Chinese flag against a blue backdrop at a desk with flowers, another flag, a bottle and a microphone.
Chinese President Xi Jinping at a joint press conference for the China-Central Asia Summit in Xian, Shaanxi province, May 19. (Florence Lo/Pool via Reuters)

China was already experiencing an economic slowdown in 2019, in part due to restrictive trade policies implemented by the Trump administration. The virus exacerbated and accelerated existing challenges, disrupting manufacturing and confining consumers to their homes.

Now, life in China is returning to normal, but its economy continues to show signs of burgeoning problems that clash with the image of an unstoppable global force.

Under current President Xi Jingping, China cemented its status as a manufacturing giant while also lifting its own residents out of poverty. In 2012, the communist nation’s gross domestic product was $8.5 trillion. By the time Xi’s second term ended, in 2022, the GDP had risen to $18.5 trillion, an astonishing growth of more than 100%.

By contrast, the Chinese economy grew by only 4.5% in the first quarter of the current fiscal year. It was an improvement over 2022, which saw only 3% growth, but still shy of the 5% target set by Beijing.

Granted, the U.S. economy only grew 1.3% in the first quarter of 2023, but some observers believe that China’s slowdown is indicative of deeper problems that could soon emerge — problems that had long been concealed by China’s insular leadership.

“Something is rotten in the Chinese economy,” investor Ruchir Sharma recently argued, pointing to what he described as “unsustainable” levels of government investment and debt accumulation.

Read more on Yahoo News: Charting the Global Economy: Business Activity Slows in China, via Bloomberg

A looming local debt crisis

Aerial photo shows the building of the Qingchi Bridge in Jinsha County, Bijie City, Guizhou province, China, May 27, 2023. (Liu Qing/CFOTO/Future Publishing via Getty Images)
Aerial photo shows the building of the Qingchi Bridge in Jinsha County, Bijie City, Guizhou province, China, May 27, 2023. (Liu Qing/CFOTO/Future Publishing via Getty Images)

After the 2008-’09 financial crisis, China allowed municipalities to use “local government funding vehicles,” or LGFVs, to borrow money to pay for infrastructure projects. The debt was principally repaid through fees generated by a booming real estate market, which gravitated toward inland regions far from the overdeveloped coast.

It was always a risky play — but never more so than today.

Real estate growth effectively froze during the pandemic, while government spending increased. Those dynamics have raised the possibility that some local governments could default on their debt obligations, triggering a broader economic crisis.

A recent analysis by the Rhodium Group found that of 205 cities surveyed, 102 had struggled with debt servicing in 2022. Analysts for Goldman Sachs recent said that they saw “risks on the rise, especially for the less developed inland regions.”

Total debt owed by LGFVs is estimated at a dizzying $8 trillion

Last year, Xi’s government announced a 16-point plan to galvanize an anemic real estate market, which would replenish municipal coffers and, presumably, keep the LGFVs from collapsing.

But so far, the measures do not appear to have worked, leading Beijing to unveil new measures to boost the real estate sector last week.

Read more on Yahoo News: Struggling China local governments find a fundraising loophole, lifeline in ‘pearl bonds,’ via Reuters

Real estate boom goes bust

 A worker walks past a construction site near a skyline of tall residential buildings.
A worker walks past a construction site near residential buildings in Beijing on April 14, 2022. (Tingshu Wang/Reuters)

Real estate accounts for about 25% of China’s gross domestic product, meaning that the sector is critical for the nation’s economic health (by contrast, real estate accounts for 17% of the gross domestic product in the United States).

As with other aspects of China’s economy, the real estate market is recovering from the prolonged period of “zero-COVID” — lockdowns and intensive surveillance measures implemented at the slightest sign of the coronavirus — which severely disrupted economic activity.

But the recovery has been faltering. Relative to April, May saw a nearly 15% drop in residential sales.

“The basic picture was one of regression,” a Bloomberg analyst recently assessed, describing the real estate sector as “still sick.”

Read more on Yahoo News: China Housing Rebound Fizzling Shows Risks to Economic Recovery, via Bloomberg

Low consumer confidence

People walk through a traditional shopping street in the Qianmen area of Beijing on May 3, 2023. (Greg baker/AFP via Getty Images)
People walk through a traditional shopping street in the Qianmen area of Beijing on May 3, 2023. (Greg baker/AFP via Getty Images)

Ultimately, whether ordinary people are willing to spend money on goods and services — condominiums, smartphones, restaurant meals — is revealing of how they see their own financial prospects.

Businesses are also unlikely to make new investments if they perceive the economic climate to be unfavorable or uncertain.

On that front, China fares poorly. Business confidence plunged after a crushing 2022; meanwhile, consumer confidence remains “weak and shaken,” Pepsi chief financial officer Hugh Johnston judged last month in an interview with Reuters.

Also, foreign investors are pulling out of China, another bad sign.

“Unlike previous cycles, we see no easy fix this time. The real barrier to sustaining the growth recovery is a lack of confidence,” economists with Nomura Holdings recently wrote.

Most analysts believe that Chinese consumers and enterprises will eventually recover their confidence, while Beijing will shore up other sectors of the economy. But that could take years. And even then, the pre-pandemic powerhouse may only live on in memory.

Read more on Yahoo News: Feeling poorer: Property slump hurting Chinese consumers, clouds recovery, via Reuters

Cover thumbnail photo: China Daily via Reuters