Capital Markets Update #17

From our vantage point, the Chinese economy is in material danger of implosion in the coming decades.  While China can continue to tread water in place, we’re not entirely sure that the economy, let alone the ruling party in power, would survive another recession.  For instance, Americans think of the stock market as a basic barometer for economic health.  That’s not an accurate analysis in China.  You need to dig deeper into the fundamentals to really understand the scale of potentially destructive forces working against the Chinese government as it attempts to centrally plan go-forward global domination.   

First, the Chinese equity markets are hyper volatile – in a sense, by design, as they basically trade on government propaganda. Compelling short-term 50% - 75% equity gains have historically been wiped out in a matter of 6 – 12 months.  What suffers is China’s long-term fundamental health, given the country (and its domestic / foreign investorship) are asked to constantly recover from severe cases of bullish and bearish delirium.  As a result, the CSI 300 index is up a mere 47% since January 2011 as compared to a 440% gain in the S&P 500.  But, in our opinion, this tells a fraction of the story.  A relatively careful analysis of historical Chinese market performance divulges the fact that seemingly every major run in the CSI 300 index over the last two decades has been a function of stimulative governmental fiscal and monetary policy.  For instance, the CSI ran about 150% from June 2014 to May 2015 following the Chinese government enabling its pseudo-governmental insurance and banking arms to ease capital controls, increase lending, and increase both foreign and direct equity investment.  The government also dolled out tax breaks and eased home ownership hurdles for Chinese households.  However, by October 2015, wanton bullishness and bad investments soured, washing about 40% of the value (nearly 70% of the prior year gains) out of the CSI 300 index.  Nearly the exact same scenario (but worse, ironically) played out in 2020 – 2021, followed by another 25% drop in equity prices associated with the widespread wipeout in household savings from the 2022 real estate crash. It wasn’t until the Chinese government committed, in Q4 2024, to use “all available measures” to stimulate domestic consumption and support Chinese companies that the CSI ran another 45% in the last 18 months.  But for the DeepSeek mania, our view is the market would have pulled back per its normal routine, but that’s pure speculation.  Regardless, once this juice had run its course, the CSI formed a relatively firm top, which has remained in-place since September 2025.

What interests us is the long-term outlook for the Chinese economy.  We see four structural issues for China in the coming two to three decades.  First, Covid supply chain disruptions, followed by President Trump’s concerted deglobalization push, thrust into stark relief the global reliance on China for critical inputs.  Unwinding China’s hegemony in manufacturing and critical material inputs could very well become a global secular headwind against Chinese GDP growth in the decades to come.  Second, The Chinese consumer is struggling dramatically, experiencing limited wage growth, high unemployment (unreported but true) and meaningful net worth destruction.  Third, China’s private property market has experienced an extraordinary basis reset, eroding consumer confidence and net worth, while also limiting critical tax receipts.  And finally, the Chinese fiscal deficit, weaking tax revenue base, and limited capacity to create net debt in the economy, means the Politburo has used and therefore lost much of its marginal fiscally stimulative power.  

According to World Bank data, Chinese manufacturing output peaked in 2021 at $4.91T and has since dropped to $4.7T.  While total Chinese 2025 manufacturing output was flat year-over-year, exports to the United States dropped 30% from about $440B in 2024 to about $310B in 2025 (US Census Bureau).   In order to find markets for the resulting goods surplus, Chinese manufacturers aggressively dropped prices.  According to Chinese government statistics, Chinese manufacturer producer prices have been contracting at a rate between 1% - 5% annualized since 2023.  Producer prices contracted by about 3% YoY in 2025, according to the Chinese National Bureau of Statistics.  Basically, China bought a bunch of new global marketshare to sustain output.  While China may be able to dump goods into trading partners such as Hong Kong (16% YoY increase in Chinese imports), Vietnam (23% YoY increase) and Thailand (21% YoY increase), it has come at the cost of price debasement for domestic industries in less amenable countries including India (13% YoY increase in Chinese imports), Germany (11% YoY increase), and the UK (8% YoY increase).  All World Exports data.  This paradigm becomes political and may prove tough to sustain in the long run.   Slowly, the EU has rolled out anti-dumping duties on fiber glass, stainless steel, ceramics, etc.  India has acted similarly, slowly rolling out single-product tariffs.  Mexico has been a bit more comprehensive.

Chinese consumer health has also waned since Covid.  You have to look at it holistically in order to really capture the extent to which the average individual has suffered.  As you know, we constantly argue against the domestic harangue that “hardworking Americans are suffering.”  This would actually qualify as suffering:  Average wage growth in China has dropped from 9.7% in 2021 to about 2% (est.) in 2025 (Chinese National Bureau of Statistics).  That includes 2.8% wage growth in 2024.  One might say “well that sounds rational” considering YoY inflation in China has dropped from about 1.8% in 2022 to 0.3% deflation in 2023 to 0.1% inflation in 2024 (Chinese National Bureau of Statistics).  So, the wage growth is all profit.  The problem is China is a savings economy – they save about 23% of income (Emerging Markets Review data).  The majority of their savings are tied up in real estate; approximately 96% of Chinese households own a home (World Population Review).  However, according to the Bank of International Settlements, real estate prices are down 23% since 2021 and that’s the houses nice enough to transact.  To put that into perspective, peak-to-trough average home prices in the US dropped 20% in the GFC (FRED and HUD data).  The reality is your average house in China today is likely illiquid, if not close to worthless.  Home sales are down 55% since 2021 (China National Bureau of Statistics).  Those of us with a stock portfolio can sell stocks in a pinch to capture cash.  Additionally, Americans benefit from about $35 Trillion in real home equity in 2025 (Federal Reserve).  However, in China, only 7% of Chinese households own stocks (Journal of Financial Economics).  So, if 96% of households invested savings in a home which today has little to no equity value, while only 7% of households have access to any other source of liquid equity value, you could be dealing with an entire country operating literally paycheck to paycheck. 

We’ll combine the last two sections as they’re related.  Going forward, the Chinese government could find it exceptionally difficult to manipulate its growth through monetary and fiscal stimulus.  The first reason being tax receipts are dwindling.  According to DWS and CKGSB, about 50% of Chinese tax revenues come from a VAT on transaction activity, another 22% comes from a combination of a consumption and income taxes.  That’s 72% of taxes coming from Chinese consumer transaction activity or income, effectively.  With deflation taking hold and real estate transaction activity down 55%, Chinese tax revenue stood at 15% of GDP in 2025, down from 18% 10 – 15 years ago.  On the flipside of revenues are liabilities.  The Chinese government reports approximately 96% government debt to GDP, which compared to the US’s 120% doesn’t seem that bad.  However, Chinese banks and insurers are effectively nationalized entities, so in many ways you can’t account for “private lending” as we would here in the US.  For instance, according to S&P global, 45% of corporate real estate debt outstanding has been made to companies with EBITDA lower than interest expense.  15% of all private Chinese corporate debt outstanding can’t meet interest expense.  Think about that, what does that mean for the credit quality of the next 35% (in total, 50% of all corporate debt outstanding) sitting on top of that 15% unable to sustain a 1.0x cover?  On top of all this bad corporate debt sits another $8 – 10 Trillion in local government debt that is truly “off balance sheet” or doesn’t accrue into the centrally reported statistics anywhere.  We cant put a completely accurate number on the total liability sitting at the foot of the Chinese government, but, when accounted for in its totality, its huge.  The Dallas Fed threw out a number close to 300% of GDP in a recent 2025 report.

So, again, you need to look at the scale of China’s task in its totality.  You have an economy which creates GDP by way of dropping prices to sell more products.  In an environment where demand for Chinese products is wavering, firms cut wages.  With savings haven been wiped out in a real estate crash, this drop in wages leads to a drop in domestic consumption, which directly impacts tax revenues.  As tax revenues fall, the primary (if not sole) means of impactful stimulus becomes unaffordable.  For an economic growth model predicated on government-backed financing, this puts China in a bit of a pickle.