Problems China Is Facing Today – 7 Big Challenges for Traders

China’s financial markets are of interest to many traders, both foreign and domestic.

However, China carries with it its own set of challenges, which we lay out in this article.

1) Real estate bubble and resultant debt problems

In China, real estate is 25% of economic activity and 70% of savings.

So the effects of China allowing a debt-financed real estate bubble to inflate and pop – with the help of regulations that forced financial prudence – is a big drag on economic activity.

It’s especially a big problem for China’s middle earners because, like many countries, real estate is an asset that the middle class locks up a significant portion of their savings in.

It’s difficult for policymakers to balance the trade-offs of:

a) moral hazard – i.e., not allowing bad lenders and borrowers to pay the price for their bad lending and borrowing – and

b) the systemic risk of allowing the financial damage to spread to lenders, businesses, and local government financing.

But the debts are denominated in Chinese currency and their leadership has extensive debt restructuring experience.

So it can be handled well in terms of:

• figuring out how much of the debt burden to write down
• how much to restructure by spreading it out over time, and
• how much to lower the cost of or monetize directly (transfer the debt from private sector balance sheets to government balance sheets)

And ideally leave lessons for the future so the same mistakes aren’t repeated.

But like most policymakers everywhere, they are more reactive than proactive.

So debt problems and asset bubbles are allowed to go wild before they put policies into place (financial metrics that key intermediaries and shadow banking entities aren’t allowed to breach and so on) that companies and markets react to.

Instead of encountering problems and reacting, it’s probably better for them to study the best practices of other countries, look at their versions of these problems, and modify these practices from there.

Of course, it’s much easier to criticize from the stands than actually managing things well in real-time and without knowing all the constraints, especially the political ones, on the actions they’re allowed to take. There are lots of difficult choices.

2) The balance between capitalism and “common prosperity”

Most foreigners are concerned about what China is doing with capitalism and technology companies, which is impacting foreign inflows, Chinese capital markets, and their domestic economy.

When Xi talks about following Marxist-Leninist thinking, many foreigners think it signals some type of U-turn in terms of Chinese leadership’s opinions on entrepreneurship and efficient capital markets.

Especially when they see people in opposing factions heading for retirement and other reformist-globalists that were part of the Central Committee heading out in favor of Xi replacing them with more conservative-nationalists who are loyal to him.

The new leadership shows concerns about the power conflict with the US and large Chinese companies/people throwing their power around domestically, which is understandable. But it’s causing many foreigners to think that China is too risky a place for investment.

What Xi means more fundamentally is not a departure from a market-based economy, but trying to balance out the interests of growing the pie while dividing it well to raise productivity and enhance social stability.

Deng Xiaoping (a market reformer in the 1980s) was practical about the necessity of China needing to be highly productive in order to have the resources they need to build out such a system.

But common prosperity at this point is still more conceptual than a clear plan.

For example, China’s income tax system, social safety nets (most notably healthcare for the poor and old, a quality state-sponsored pension system), and regulatory systems are not well developed.

It doesn’t collect capital gains taxes or inheritance taxes like most developed countries.

Its messaging to its people and the rest of the world on its policies are too ambiguous and the shifts too abrupt. How they balance these trade-offs and how they regulate are heavily unknown, though probably imagined to be more dangerous than whatever they will actually do.

3) Demographics

Demographics hurt economic growth in China.

While this is true in most developed countries as well, in China’s case, it is a bigger problem than in most other countries.

Adult children in their 40s and 50s have a large economic and time burden on them because China’s lack of developed pension and healthcare systems means it’s on them to provide for older generations.

4) Weakening economic activity and the global inflation problem

When the world economy gets weaker and tighter monetary policies to rein in inflation hurt Chinese exporters and Chinese capital inflows.

5) Conflict with the US hurts economic activity

The conflicts with the US over trade, technology, capital markets/economics, geopolitical influence, and the risk of a military conflict hurt activity.

For example, the building of self-sufficiency in various ways is costly and doesn’t produce much in terms of new growth because it’s simply replacing existing systems and ways of operating.

Companies are shifting production away from China to places like Mexico, Vietnam, and India, and investors are doing the same.

The US looking to pass a bill in the House supporting the independence of Taiwan may seem noble, but just exacerbates existing tensions. The Taiwan issue is very serious to the Chinese and doing such things could be tantamount to a declaration of war and increases the odds of some type of military conflict with China.

Just the possibility has damaging consequences. The combination of elections in the US and Taiwan, Japanese rearmament, and the fall in economic activity make the upcoming years an especially risky period.

Decision-makers in both the private and public sectors are less inclined to make decisions that could be perceived as bad ones, which is negative for growth and improvement.

6) Climate and environment

Droughts, floods, weather/climate issues, and other acts of nature have toppled more civilizations than just about anything else.

This has been a recurring theme throughout Chinese history.