The 'Earth’ talk about the Chinese economy is a travesty

The author is chairman of Rockefeller International

Something is rotten in the Chinese economy, but don’t expect Wall Street analysts to tell you about it.

In my experience, there has never been a greater disconnect between some investment bankers’ perceptions of China and the murky reality on the ground. Reluctant to back off their calls for a renewed boom this year, sell-side economists are sticking to their forecasts for GDP growth in 2023, now expecting it to come in above 5 percent. That’s more optimistic than the official target, and completely unrelated to the bad news from Chinese companies.

It is based on the premise that Chinese consumers will spend once they are freed from the lockdown, but company reports show no sign of that. If China’s economy is growing at 5 percent, corporate earnings should grow faster than 8 percent based on historical trends. In contrast, revenue grew 1.5 percent in the first quarter.

Corporate earnings are now growing more slowly than officially reported gross domestic product in 20 of China’s 28 sectors, including consumer favorites from autos to home appliances. Weaker earnings also weighed on earnings at consumer goods companies, which typically track GDP growth more closely, but shrank in the first quarter. Instead of a rush to reopen, the MSCI China stock index has fallen 15 percent from a January peak and consumer discretionary stocks have fallen 25 percent since then.

If the analysts are right, and consumer demand has been described as a „boom” economy, then imports will be strong. Imports fell 8 percent in April. When retail sales and industrial production came in below analysts’ estimates last week, one attributed it to „seasonal adjustment,” as if spring had unexpectedly arrived this year.

China’s credit growth is also weakening, growing by just Rmb720bn ($103bn) in April, half as fast as forecasters expected. Chinese consumers’ debt service burden has doubled over the past decade to 30 percent of disposable income—three times that of the United States. Many young Chinese need work before they can join the spending spree: unemployment among urban youth has risen to 20 percent last month.

These facts point to the source of the rot. Since 2008, China’s economic model has been based on government stimulus and rising debt, much of it poured into property markets, which has become the main driver of growth. The government was more restrained in its stimulus spending during the pandemic because debts were so high.

Earlier this year, Chinese have accumulated excess savings during the pandemic, equivalent to 3 percent of GDP. A comparable figure in the United States was 10 percent of GDP. While the U.S. got a big reopening boost from the stimulus, China didn’t get one this time.

A growth model dependent on stimulus and debt was always unsustainable and now it has run out of steam. Much of the stimulus in the past decade has flowed through local governments in China, which have used their own „financial vehicles” to borrow and buy real estate to prop up property markets. Those vehicles are rapidly running out of cash to fund their loans, which limits their investment in the property market and industry. Industrial sectors are declining faster than the consumer-related businesses at the heart of the reopening story.

Although Beijing still aims for 5 percent growth, its potential has halved. The potential for GDP growth is a function of population and productivity growth: China’s negative population growth means fewer workers are entering the labor force and high debt reduces output per worker.

China’s government has long been suspected of massaging its GDP numbers to meet its growth targets. But the cheering from Wall Street now appears to have peaked, as analysts calling for a renewed uptrend see more room for the trend to continue, albeit requiring a more selective use of official data than reversing itself.

While analysts lose out on rosy predictions, the rest of us do. „Earth” talk has contributed to the loss of hundreds of billions of dollars by investors in China over the past four months. Also, global growth may be weaker than expected in 2023, as China’s reopening boom will be countered by a U.S. downturn that may never come. It is time to expose this travesty before the fallout worsens.