Is China’s Economy Entering ‘Historical Garbage Time’? Part 1

China’s economy is in trouble.

Here’s how the FT summarizes the situation, in traditional economic language.

China’s underlying structural challenges range from high government debt, demographic decline and youth unemployment to growing tension with trade partners.” – The Financial Times (October 21, 2024)

But a “new meme of economic despair” has emerged to characterize the pessimism that many Chinese feel.

“China’s sputtering economy has prompted a dire, new shorthand online for pessimism about the prospects for any turnaround for jobs, incomes and opportunity: ‘the garbage time of history.’ The apparently made-in-China phrase injects a term from basketball – the ragged final minutes of a game when the outcome is no longer in doubt – into what started as a discussion of history and has since become a heavily censored online discussion about whether China’s workers and investors should give up.” – Reuters (July 17, 2024)

It is more than just a gloomy outlook. “Garbage time” implies loss and inevitability. The game is hopeless.

It refers to an American sports term used to describe low-quality play at the end of a match when competitors run out the clock because the result is already clear. Chinese netizens adopted it to express their feeling that China is stagnating.” – The Economist (November 7, 2024)

The Great Stall Of China

According to the IMF and the World Bank, China’s growth has stalled. GDP has declined (in dollar terms) over several years.

After two decades of growth, China’s economy is now said to be “on the ropes.” The situation has been portrayed in Western media under three different scenarios:

As a side-effect of China’s strict anti-Covid policies, which would disappear when those measured were lifted
As a Cyclical Recession, where a natural recovery may be expected in the not-too-distant future (for a while it was viewed as simply a side-effect of anti-Covid measures, which would disappear when those measures were lifted – but this did not happen)
As a vast Structural Seizure stemming from constellation of serious and persistent challenges – demographic, fiscal, social, geopolitical – leading to the “Japanification” of the economy (by analogy with Japan’s lost decades after 1990), a “new normal” characterized by intractable stagnation at a low level of performance

The practical distinction turns on the question of what sort of economic policy should be pursued by China’s leaders.

The end of zero-Covid policies in late 2022 was expected to usher in a new economic boom, without any special economic policy adjustments. This obviously has not happened.

For the cyclical case, moderate, cautious, and “prudent” adjustments would be appropriate. This has been Beijing’s traditional approach. It does not seem to be working either.

But if the problem is structural, “bold and dramatic” measures will be needed. What that policy departure might mean is Beijing’s current preoccupation. The Western media has largely bought into the Japanification threat, and focuses on whether China should, could, or will institute a much more aggressive economic stimulus.

Chinese authorities, to the extent that they acknowledge a problem at all, still see it as a manageable one. Although they also frequently claim that China’s GDP has not declined at all. In January 2024, Premier Li Qiang’s keynote January 2024 told the World Economic Forum in Davos that “China had not only met but in fact had exceeded its projected GDP growth target of 5 percent for the year” and last week Beijing reported that “major targets and tasks of economic and social development were achieved successfully” to allow growth to once again beat the 5% target in 2024. (Foreign experts calculate much lower numbers. A close study of China’s controversial GDP statistics is a topic for another column.)

And in any case, the Beijing mandarins have a plan. New stimulus measures approved last year will kick in – indeed, they have already done so. Things are bright and getting brighter. Even singing…

“Singing Bright Prospects” In China

Beijing celebrated its non-problem with new messaging…

“Following the December 2023 Central Economic Work Conference, the party began feverishly promoting a new propaganda initiative: the “theory of singing the bright prospects of China’s economy.” Secretary of the party Secretariat Cai Qi told the National Propaganda Ministers’ Conference in January that the “bright prospects theory” is directly linked to the “two establishes” and “four comprehensives,” two key pillars of Xi Jinping Thought.”

…with exhortations…

“China’s Economic Times rallied its readership, enjoining them to ‘make our voices loud and clear, tell the world the true situation of the Chinese economy, and enable international investors to make rational choices based on facts.’

…and threats.

The Ministry of State Security joined the growing ‘bright prospects’ chorus by issuing a series of warnings that any opposing “theories” were nothing but “discourse traps” and “cognitive traps” promulgated by four different kinds of “short-sellers” and market “bears” who are threatening the nation’s economic security.”

But not everyone can see these “bright prospects.” After several years of intense social and economic stress – partly a consequence of the zero-Covid regime, and of its abrupt and chaotic abandonment (as described in previous columns, here and here) – many Chinese are apparently beginning to feel a sense of fatigue and powerlessness in the face of socio-economic forces that seem increasingly unmanageable.

And so, an alternative narrative has emerged.

A Striking Metaphor

In November 2023, a popular columnist for Caixin (an independent Chinese media group) highlighted a striking new metaphor:

“When a certain period of history runs against all economic logic, and ordinary individuals cannot change the trajectory of time, [the system as a whole] is doomed to failure. We define such periods as ‘historical garbage time’.”

Initially a description of the sclerotic final years of the Soviet Union, it was also applied to certain episodes in ancient Chinese history, and then to “the dilemma of national modernization.”

One lightly-veiled allusion led to another, and soon…

“By the Chinese New Year holiday in mid-February of 2024, ‘historical garbage time’ was in such widespread use across various social media platforms that students on university campuses throughout the country were discussing and debating how best to survive it.”

Eventually, the commentary in non-Chinese social media drew the connection directly with Beijing’s current polices. Commentators outside Beijing’s censorship reach called the Party’s proposed economic reforms a “garbage draft in garbage time” with “no new content” and declared that Chinese history “has indeed entered garbage time.”

As the internet chatter amped up on both sides of the Chinese firewall, the government felt a need to respond. Regime spokesmen termed garbage time a “sham academic concept,” a “grand narrative trap,” based on “blatantly counterfeit terminology” – but it has not impeded the viral spread. (For a very readable account of the emergence of this wicked new meme, I refer the reader to an excellent piece by Patricia Thornton of Oxford University, here.)

Is It Garbage Time in China?

Has the country boxed itself into a situation where Beijing is losing the ability to manage things? Is the stagnation fixable within the constraints of China’s geopolitical ambitions, while also respecting the one overarching and all-important constraint – the survival of the Chinese Communist Party?

The Wall Street Journal (January 14, 2025) tells us “China has no easy answers” – another way perhaps to say “yes, it is garbage time.”

The signs loom in the headlines, in five areas:

Monetary Policy Challenges – threats to the value and integrity of the Chinese monetary system
Challenges involving Economic “Fundamentals” – consumption, production, wealth and poverty
Challenges involving the Management of Financial Markets
Fiscal Challenges – taxes, debt, government spending
Existential Challenges – social, cultural and demographic problems

In this column, I will consider the only first category: problems connected with China’s ability to stabilize and control its monetary framework. These include: deflation, devaluation, capital flight, and the collapse of foreign investment.

1. Deflation

The Chinese economy is characterized by chronic overproduction, and equally persistent underconsumption. On the supply side, many sectors suffer from overcapacity and poor profitability. On the demand side, consumers save far too much, and spend far too little. This is nothing new. It is the mainspring of China’s long-standing export-driven business model.

The effect on the value of the currency is always inherently deflationary. Oversupply and insufficient demand put downward pressure on prices. While this may help drive exports, it smothers the domestic side of the economy. Consumer sentiment is depressed, and consumers pull back on spending. Debt service becomes more burdensome. Companies’ profit margins are squeezed, driving cost cutting, and higher unemployment – suppressing demand even further.

“In September, China’s producers marked their second consecutive year of deflation, a trend that puts intense pressure on corporate earnings. Even exports— the engine of China’s economy — unexpectedly slowed in dollar terms during the same month.” – The Financial Times (October 21, 2024)

Falling prices are both cause and effect.

Consumer prices are flirting with deflation.

Producer price deflation is deeply entrenched.

Deflation is not an easy subject to make sense of, in part because it is something we haven’t seen here in almost a century. With all the anxiety in the United States today over inflation, many may ask how could falling prices be a bad thing, even “dangerous” (as so many economists claim)? Wouldn’t it be better if goods and services were always tending to get cheaper, more affordable?

And yet, the worst depressions in modern history have been associated with deflation, and in part caused or intensified by it. In the United States, the decades following the Civil War saw a long-term deflationary trend driven by rapid industrialization – and the country experienced two deep depressions (in the 1870’s and the 1890’s), and grinding impoverishment of the agricultural sector, where deflation was most intense, that lasted into the 1930’s.

A report from the Brookings Institute describes the down-spiral inherent in a deflationary economy –

“Deflation helps feed the contraction in demand and real activity that initiated it. The unexpected price declines hurt borrowers, increase bankruptcies and foreclosures, and threaten the solvency of banks, which are then forced to restrict credit. As the expectation of falling prices takes hold and interest rates cannot adjust adequately, even buyers not dependent on credit hold back on spending. Through these channels, the 25% drop in consumer prices in the four years after 1929, along with the even sharper drop in wholesale prices, fed the downward spiral of real activity that was the Great Depression.”

There are structural signs that the China may be tipping into a deflationary psychology. The private sector is dispirited. Consumer spending is softening even further.

China’s economy is grappling with weakening consumer demand… The role of consumption in driving economic growth has waned, declining by 1.7 percentage points from the first quarter. – The China Daily News (the Chinese Communist Party’s house organ)

The Center for Strategic and International Studies writes that “consumption as a percent of GDP in China has fallen considerably over the last two decades” – declining from 64% to 53%. (For developed economies, in contrast, consumption typically accounts for 75% or more of GDP.)

About all this, Beijing is officially and vociferously in denial. “There is no deflation in the Chinese economy, and there will be no deflation in the future,” the Chinese National Bureau of Statistics has proclaimed. But the symptoms are there. The negative and near-negative trends in China’s consumer and producer price indexes signal of a level of distress that may be deeper than China’s authorities appreciate.

2. Devaluation

Deflation should normally increase the value of the currency, and raise purchasing power. But China is experiencing both deflation and currency devaluation at the same time.

The Yuan has been losing value for several years. This week it reached the lowest level against the dollar in 15 years. It is down 16% against the dollar since early 2022, and down 4.5% in just the last 3 months. The Chinese consumer’s purchasing power to acquire foreign products has been cut by 1/6^th.

Currency weakness aggravates negative sentiment among investors, both foreign and domestic, eroding demand for Chinese assets and undermining Chinese financial markets.

The cost of servicing dollar-denominated debt rises. According to China’s State Administration of Foreign Exchange, the country has about $1 trillion in outstanding dollar-denominated debt today. It is about 15% more expensive to service new (or existing floating rate) dollar debt than would have been the case a couple years ago.

The cost in Yuan of China’s dollar-priced imports is up by 15%. This includes about $325Bn for imported oil and $350Bn for imported semiconductors.

There is a greater threat, however. As the Yuan loses value, many Chinese seek to shift their assets out of the domestic currency to a safer store of value, such as gold or the U.S. dollar. This drives capital flight, a truly dangerous trend, over which the government seems to be at risk of losing control.

3. Capital Flows and Capital Flight

Capital flight happens as rich and even middle class Chinese move their wealth out the Yuan and out of China. It has been a major problem for Beijing in the past decade. In 2015, severe pressure on the Yuan led to a “torrent of capital leaving the country” – $843 billion in one year according to Bloomberg. The government was forced to institute strict capital controls, undermining Beijing’s strategic objective of elevating the Yuan to a reserve currency to compete with the Dollar.

Capital flight appears to be on the increase once again. It can be difficult to measure directly, but there are indications of a new outward “torrent.” In November, China suffered the biggest outflow on record from its financial markets.

“Domestic banks wired a net $45.7 billion of funds overseas on behalf of their clients for securities investment, according to data released by the State Administration of Foreign Exchange on Monday. That amount accounts for foreign investment in China as well as local residents’ purchases of overseas securities.” – Bloomberg (Dec 17, 2024)

Data provided by China’s State Administration of Foreign Exchange for the quarterly capital and financial account balance show a steady outflow cumulating to $1 Trillion from the beginning of 2019 to June 2024.

Capital flight is a serious problem for China. Transferring wealth out of the country means selling domestic currency and other assets, which drives down prices, and contributes to further devaluation as well as to the stagnation in China’s stock market. In a managed economy, capital flight can create systemic risks and financial instability.

4. The Collapse of Foreign Investment

Foreign direct investment (FDI) in China could help offset capital flight. Unfortunately, FDI is in deep decline even as domestic capital is fleeing the country.

For many years after China’s “opening,” Western firms flocked to invest in the country, drawn by the prospect of a billion and a half potential new consumers purportedly eager to join the global economy. For companies entering from mature markets, with well-established brands and proven business practices, China represented virgin economic territory, highly attractive on a vast scale. It might take time, but the eventual payoff looked to be enormous.

In the 10 years from 2011 to 2021, net FDI funds flowing into China amounted to more than $2.6 Trillion.

This flow abruptly collapsed in 2023, falling 95% in two years.

By 2024, the direction of the flows had reversed altogether. Western firms were taking more money out of China than they were reinvesting.

As one blog put it: “Foreign Investors Hit ‘Sell’ on China in 2023.”

Summary

These four factors — deflation, devaluation, capital flight, and the level of foreign investment – are some of the major considerations that Chinese authorities must take into account in designing and executing monetary policy. They are interrelated, and not always felicitously.

Deflation and its consequences (weak domestic demand) are not encouraging for investors, foreign or domestic. They depress public sentiment, and sap the entrepreneurial spirit. Devaluation has been seen as a countermeasure to fight deflation (Roosevelt did so in the 1930’s when he raised the price of gold, devaluing the dollar, to fight the severe deflation associated with the Great Depression.) But devaluation also hurts public sentiment, as Chinese citizens see the purchasing power of their assets on the global market decline, and encourages capital flight. This puts pressure on the financial system, and can fuel further devaluation. And weak currencies unsettle foreign investors, helping to suppress the inflow of foreign capital – which is also impacted by deflation-induced softness in consumer spending. The loss of trillions of dollars in market value for Chinese companies since 2021 (while other equity markets have surged) is perhaps another aspect of “garbage time.”

In short, China is suffering from deflation, devaluation, capital flight and the loss of foreign investment — all at the same time. I don’t think we seen this before. When Japan suffered is deflation in the 1990s, the Yen strengthened ferociously. There was no capital flight, and no reduction in inflows of FDI to Japan. China’s problem-set seems much more complex than mere “Japanification.”

It all looks pretty grim. As the game grinds on, Team Xi seems to have lost the ability to manage the outcomes, and Chinese citizens are losing hope. That’s “garbage time.”