What’s next for China now that the Communist Party Congress is over and President Xi has solidified his power as the strongest Chinese ruler since Mao Zedong? China’s problems are well-known, including excessive non-payable debt, capital flight, corruption, pollution, and wasted infrastructure investment.
The expectation is that President Xi will begin to address these structural problems from a platform of political strength. If he fails to do so, China will face an unpleasant choice between a financial collapse (with emergency government bailouts to follow) or a “lost decade” of slow growth because of the debt overhang.
On the other hand, if Xi does take concerted action to write off bad debts, close insolvent state-owned enterprises, eliminate excess capacity, and redirect resources from wasted investment to consumption, China will face a sharp severe recession that could be socially destabilizing as unemployment temporarily soars.
Given the choice between a sharp immediate correction, and a long, drawn-out “lost decade” politicians usually opt for the latter (Japan after 1989, and the U.S. after 2008 are good examples). This article describes some of Xi’s early reform steps, which are giving investors a serious wake-up call.
The Chinese stock market has sold off sharply in recent days. But, it still appears that despite the reforms, Xi is pursuing a moderate approach not a radical approach. The problem is that the Chinese economy is so large that even a moderate slowdown will negatively impact economic growth in much of the world including Australia, Canada, Southeast Asia and even the U.S.
The weakness in Chinese stocks today may soon carry over to U.S. stocks as it did in August 2015 and January 2016. What happens in China doesn’t stay in China.