China has experienced decades of sustained economic growth – “the most impressive economic miracle of any economy in history” – But is it coming to an end?
A prolonged downturn would have major geopolitical implications.
- “China’s rapid growth meant that for years forecasters expected China to overtake the U.S. as the world’s largest economy. As recently as 2019, some forecasters were expecting China’s GDP to eclipse the U.S.’s around 2030, Today it is the U.S. that is powering the global economy and China that is battling stumping growth. Few now expect China to catch up…”
Many observers have compared China’s current malaise to the grinding economic stagnation that Japan suffered in the decades following the crash of its real estate market in 1990.
How real is this dire analogy, often called “Japanification”?
Consider the parallels.
The Stock Markets
Equity markets mirror the overall economy, often more accurately than official statistics. The CSI 300 – considered the Chinese equivalent of the S&P500 – is down 36% from its all-time peak four years ago this month.
This is somewhat less drastic than the plunge in Japan’s Nikkei 225 from its peak in December 1989, but the correlation is strong.
Stocks got a bounce from the Communist Party’s Third Plenum in mid-July, 2025. This is a meeting of the leadership of the Party, held every five years, at which important economic policy decisions are announced. The July session was described in advance as “a milestone moment in China’s history” where it was widely anticipated that the government would announce a shift towards a strong economic stimulus.
The brief bubble deflated quickly, as disappointment with the government’s weak policy response set in.
- “Rather than unveiling bold reforms, the communique that followed the plenum reads like a lengthy endorsement of the leadership of Xi Jinping, China’s strongman leader, and his existing policies. It stated that the Central Committee gave a “highly positive assessment” of Beijing’s work.”
What does the future hold? The Japanese stock market slide in the early 1990’s stabilized somewhat at the 4-year mark (although it fell further afterwards).
Will Chinese equities continue to track this trajectory? Geopolitical uncertainties, tariff and trade measures, and the prospect of tension with both the U.S. and the EU, all suggest further “moderation” ahead.
The Housing Market
The Economist describes it as “history’s wildest property boom” – and it is now “history” indeed. The boom is well over, and China’s housing crisis lies at the heart of the current economic downturn. Real estate prices have collapsed. Companies responsible for 40% of China’s home sales are in default.
- “Hundreds of real estate developers have filed for bankruptcy in recent years and dozens have been delisted, including some large builders whose annual sales once exceeded 100 billion yuan. Many listed private developers have fallen into a spiral of debt restructuring.” – Caixin Global China Watch (Feb 4, 2025)
The parallel with Japan’s real estate crash in the 1990’s is striking although Chinese housing prices have fallen much faster.
Hong Kong housing prices show an even sharper decline. (Economic statistics provided by Hong Kong are generally considered more reliable than figures supplied by Beijing.)
The effects of real estate crashes are very prolonged. In the United States, it took 15 years for residential property prices to recover back to the pre-crash peak set in Q3 2006. In Japan, Spain, and Ireland (countries which experienced major housing bubbles), prices never fully recovered. If this is any indication, China’s housing crisis is only in its early stages.
In addition, the overhang of unsold inventory is enormous, especially relative to current sales rates.
- “China’s unsold inventory of housing would amount to RMB 93 trillion ($13 trillion). By comparison, there will be an estimated total of about RMB 9 trillion ($1.3 trillion) in property sales this year.” – Goldman Sachs Report (November 2024)
(As a point of reference, the value of unsold housing inventory in the U.S. at the peak of the subprime crisis in 2007/8 was about $1 trillion, or 7% of the U.S. GDP at the time. China’s backlog is more than 10 times larger, equivalent to about 70% of China’s current GDP.)
Debts, Public and Private
The debt picture in China is sharply bifurcated. Trends in government indebtedness are quite different from trends in private sector indebtedness. Public sector debt expands in a crisis as a result of fiscal stimulus and relief programs. The private sector sees an opposite trend, as companies retrench and pay down debts to defend and rebuild their balance sheets.
Public Sector Indebtedness
A key aspect of “Japanification” is the rapid growth of government debt. Following the onset of the economic stress, both Japan and China show a strong upward inflection in government debt as a percentage of GDP.
(In China’s case, 2015 is chosen is Year 0. That was when official GDP growth fell to 5% for the first time in the “open China” era, a distinct slowdown after having averaged 15% annually for the previous two decades).
Japan entered its crisis with a higher level of public debt, but China’s debt level has accelerated faster.
Private Sector Indebtedness
Corporate debt typically grows prior to the crisis. Infact, this accumulation of leverage helps create the conditions for the crisis that ensues. The trend slows and reverses as the downturn sets in. In Japan after 1990, corporate profits were squeezed. Corporate borrowing slowed, and after a few years companies begin to deleverage aggressively. It was a “balance sheet recession” as identified by economist Richard Koo. Many Japanese firms went into survival mode and focused on paying down their debt rather than investing for growth. This shift to thrift was a major contributor to Japanification.
China’s private sector has not started serious deleveraging yet. But it seems to be poised on the threshold of a similar shift. After expanding indebtedness from 87% of GDP in 2007 to 141% of GDP in 2023, borrowings appear to have slowed. If this is followed by a major deleveraging, it will create a significant drag on economic growth.
The Bond Markets
Another symptom of Japanification is a significant decline in bond yields, reflecting a general “flight to safety” by investors shifting from risk assets (like stocks) to haven assets (government bonds). As demand for bonds surges, prices rise and yields fall.
Japan (in the 1990s) and China today show a similar pattern. In China’s case, bond yields have fallen to an all-time low, and many observers are diagnosing a dangerous “bubble” in the bond market.
A strong bond market is not a straightforward sign of economic health. The bond rally here is linked to private sector’s shift to thrift. Banks are buying bonds because they can’t generate new loans to a private sector which doesn’t want to borrow.
- “Chinese commercial banks have a huge problem. With consumers and businesses gloomy about the prospects of the world’s second-largest economy, loan growth has stalled. Beijing’s stimulus push has so far not been able to spur consumer credit demand, and is yet to spark any meaningful rebound in the faltering economy. So what do banks do with their cash? Buy government bonds.” – CNBC (January 9, 2025)
As the rally becomes a speculative bubble – that is, as investors and traders start to bet on a continuing uptrend in the bond market – it starts to make things worse. Surging demand for government bonds sucks even potentially willing investment capital out of the economy and parks it in unproductive hands (the government’s coffers).
The situation mirrors the gloom in the stock market and the housing market.
- “Investors have turned to bonds amid a prolonged property crisis, weak consumption and concerns over deflation. China’s currency has fallen toward a record low offshore.”
A consequence of the bond bubble is that Chinese yields have fallen now more than 320 basis points below the yield on U.S Treasurys – a shift of more than 550 basis points in the spread in the last four years.
Low relative yields in turn drive capital flight – who wants to earn 1.6% on Beijing’s paper when Treasurys are paying 4.5%. This puts intense pressure on the Yuan. In January, the currency fell to its lowest level in decades. To relieve the burden on the Yuan, the Chinese central bank suspended its own bond-buying. This may help the bond market somewhat, but it also removes an important instrument of monetary policy from the Central Bank’s toolkit.
Inflation & Deflation
A deflationary trend in prices was a prominent feature of the post-1990 period in Japan. Recent prices in China have followed a similar trajectory.
Deflation can wreck an economy, driving it into a downward spiral of diminishing demand, rising unemployment, lower business profits and reduced investment. It is both symptom and cause of the woes of Japanification.
Unemployment
The stresses in China’s financial system are beginning to create socio-economic dislocations. One important metric is unemployment — especially youth unemployment. In both Japan and China, Japanification created a surge in the numbers of young people out of work.
In China, especially, the rate of youth unemployment has exploded. The government responded by suppressing the data for a period of time. The metric was eventually reintroduced with an adjusted calculation that produced a lower figure.
- “The government stopped reporting the rate in June 2023, after it had risen continuously to record high of more than 21 percent, as high as 40 percent in rural regions or as high as 50 percent when you factor in part-time or underemployment. The methodology behind the measure, however, has now been revised to exclude students. The lower result though, is still about three times the overall unemployment rate in China (5.1 percent) and reflects the quandary facing young people there.”
Data scrubbing has not reversed the trend. Even the revised figures (charted above) are still going up.
Youth unemployment in China is considered to have serious social and political implications, beyond merely the challenges of individual joblessness. It is associated with delays in marriage and starting a family, which are important in Chinese culture. This exacerbates the country’s alarming decline in fertility, with significant economic impacts on the social safety net and the fiscal calculus. It projects a demographic crisis in the decades ahead with fewer young workers to support a growing population of retirees. It impacts national productivity, and weakens overall economic growth. It undermines the social contract underlying the educational system, as unemployment seems to be acute among the more highly educated segments of the the young population. Stubborn joblessness is now becoming associated with forms of personal and collective resignation – the “lying flat” phenomenon (躺平) among young people opting out of the traditional work ethic, which has the authorities very concerned.
Reversing this trend may take a long time. In the Japanese case, unemployment did not begin to decline until 14 years after the onset of the crisis. If the same pattern holds in China, it may mean that a new “lost generation” is being created.
Summary
These trends show China tracking the Japanese experience quite closely. The only significant departure from the “classical” Japanification pattern is the sharp devaluation of the Chinese currency since 2021. It is a striking and important difference. When the crisis hit Japan, in the 1990s, it caused a powerful strengthening of the Japanese Yen, which nearly doubled in value on the following five years and offset some of the economic pain suffered by Japanese companies and consumers. China’s currency, in contrast, declined to a multi-decade low in January 2025. This anomalous devaluation – described in a previous column – is a sign of potential systemic instability. Japanification 2.0 – or perhaps we will call it Chinafication some day – could turn out to be even more challenging than the original model.
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