The re-election of Donald Trump, along with the red wave that swept through the U.S., is likely to have significant repercussions for China at a sensitive time, and with no end in sight. The Trump campaign advocated for 60 per cent tariffs on Chinese goods entering the United States, and for removal of China’s Most-Favored-Nation trade status, none of which feels like it was pure rhetoric.

New trade friction will go down like a lead balloon in Beijing, where the government, spooked by the faltering economy, is trying keenly to stabilize it. This was evidenced again last Friday, when the finance minister Lan Fo’an announced a 6 trillion yuan ($839 billion), 3-year refinancing programme for some local government debt, and an option to re-allocate some 4 trillion yuan ($558 billion) of previously allocated infrastructure funds towards refinancing. 

This fell a long way short of the type of stimulus for which financial markets and analysts had hoped.

If Trump’s tariff proposals, and other possible controls on goods, are implemented, they could clip at least 0.5-0.75 percentage points off Chinese economic growth in the first year initially, and go on to accentuate the decline in supply chain concentration on the mainland. Beijing is likely to respond more aggressively than the tit-for-tat measures it took in 2017-18. It could allow its currency to depreciate, impose sanctions on key American companies, tighten access to or ban the sale of critical raw materials, and emphasize its already uniquely substantial industrial policies. 

…there are deep-seated doubts as to whether [the government] even has the political conviction and appropriate policy agenda to address China’s systemically flawed and deflationary economy. 

Chinese equity markets, having enjoyed a rare and significant flurry since the start of the government’s major economic stabilization measures two months ago, will now have fresh concerns as the new year approaches. The government can probably stabilize the economy for the time being, but there are deep-seated doubts as to whether it even has the political conviction and appropriate policy agenda to address China’s systemically flawed and deflationary economy. 

Stabilization measures

Government measures announced in September centered around a package of interest rate, monetary and real estate easing initiatives, and an 800 billion yuan ($112 billion) programme of financing facilities allowing listed firms to buy back their own shares, and non-bank financial firms to buy equities. 

Markets and market confidence certainly rose, but the linkages between the stock market and the economy are tenuous, and the main beneficiaries were mainly state banks and enterprises, and an already privileged party-state business elite. Higher subsidies to state enterprises to buy up unfinished homes were also announced, but the overhang of the latter looms heavily over the real estate market with the stock of unsold homes, disproportionately situated in smaller towns and cities, estimated to amount to about 3-4 years of sales at current rates.

In any event, China is arguably in a liquidity trap, so that the economy’s sensitivity to these monetary initiatives is low. Many economists insist the government needs to do more on fiscal policy and much more to boost consumption to pull China out of its deflationary funk. Property and producer prices have been falling without a break since 2022, consumer prices are flat, and the broadest measure of inflation, the GDP deflator, has fallen for 6 of the last 7 quarters in the longest and largest period of decline since the Asian crisis in the late 1990s, and before that the Cultural Revolution. 

Yet the official responses have been weak. 

Last month, the finance minister said that government borrowing would rise for the rest of this year and that local governments would be encouraged to use about 2.3 trillion yuan ($324 billion) of borrowed but unspent funds in the last months of 2024. They would also be allowed to borrow to buy unused land and unsold properties.

He was expected to announce a much more substantial fiscal relaxation after last week’s conclusion of the National People’s Congress Standing Committee. However, he announced only that local governments would be allowed to issue and swap 6 trillion yuan of new debt over the next 3 years for more expensive, so-called ‘hidden debt’ — mainly owed by local government finance vehicles (along with a 5 year option to re-allocate another 4 trillion yuan of debt). The IMF has estimated such debt at 60 trillion yuan ($8.4 trillion), or up to a third more. These programmes, started in 2015, are really about financial engineering. They help local governments to save some limited money, buy time, and pay arrears but they do not boost the economy or consumption.

Xi Jinping is not opposed to reform but his reform agenda is quite different from the one that many economists, including in China, favor. 

The government has also stated that it will issue new debt to help recapitalise major state banks. Yet, those in most need of new capital are the other 4,000 or so small and medium sized banks that are less systemically important individually, but potentially risky collectively because of weakness in their funding structures and links to their bigger brethren.

Economy still challenged

Notwithstanding any additional easing that might follow greater clarity on U.S. trade policy, it should be possible for China to hit or get close to its 5 per cent GDP target for this year, and to mitigate the slowdown that was on the cards for 2025. 

Stabilizing the domestic economy is necessary, but can only get the government so far. It is unwilling to change tack and embrace a more radical, pro-consumption and pro-services shift in its economic model and strategy. Industrial policy geared towards strengthening national security and self-reliance remains the government’s lodestone. 

Xi Jinping is not opposed to reform but his reform agenda is quite different from the one that many economists, including in China, favor. This would provide for sustainable expansion of the household income and consumer demand shares of the economy, more income redistribution, the promotion of private enterprise, and extensive tax and local government reforms. These, however, all entail a redistribution of political power, which is anathema to the authorities. 

The prominent Chinese economist, Xiang Songzuo of Renmin University, asked to comment recently on the Nobel Economics prize winners’ award for 2024, noted that, “Only by moving forward towards further marketising our economy, emphasizing the protection of intellectual property, private companies, fair market competition and upholding the spirit of entrepreneurship, can our economy attain sustainable growth and our people have higher incomes”. 

None of this, though, is on Xi’s radar. Indeed, as the economist Hyman Minsky taught us, the craving for stability risks creating the very instability it is designed to avert.

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