It is said that if it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck. Something similar might be said of today’s Chinese economy. If it strikingly looks like the Japanese economy did before and at the very start of its lost economic decade, then all too likely China is at the start of its own lost decade. 

Before Japan’s lost decade, it had the mother of all housing and credit market bubbles. Indeed, in the late 1980’s it was estimated that Tokyo’s Imperial Palace was worth more than all of California’s real estate. At the same time, the price for joining a golf club was an astonishing $3 million. 

Over the decade following the 2008 Great Economic Recession, China had a housing and credit market bubble at least as great as that of Japan in the 1980s. This occurred as the result of an ultra-loose monetary and fiscal policy response to that recession. According to the Bank for International Settlements, over a decade Chinese credit to its non-financial sector increased by around 100 percent of GDP. Meanwhile, according to Harvard’s Kenneth Rogoff, house prices in relation to income in China’s major cities had become more expensive than those in London and New York. Mr. Rogoff also estimates that the Chinese property sector came to account for a staggering 30 percent of its economy. That is some 50 percent more than in most major developed economies. 

At the start of Japan’s lost economic decade, home prices stagnated, housing investment collapsed, property developers started defaulting on their loans, and signs of generalized deflation began to set in. Something eerily similar is now occurring in China. 

Over the past year, Chinese home prices have stagnated while the housing market is now characterized by a huge property overhang. It is estimated that over nine million homes are unoccupied, while many housing units that have been started remain uncompleted. At the same time, many property developers, including, most notably, Evergrande and Sunac Holdings, have begun defaulting on their loans in a major way. 

Adding to China’s dismal long-run economic outlook is the fact that its population has started to decline, its government is rolling back the economic reforms that underpinned its earlier economic leap forward, and its local government’s finances are rapidly deteriorating as land sales have ground to a halt. As if that did not constitute a sufficient headwind to its economic growth prospects, China is now having to contend with a rapid shift to more protectionist trade policy towards China in the West.  Underlining this trend is the fact that the Biden administration did not roll back former President Trump’s tariffs on Chinese imports, Trump is threatening to impose a 60 percent tariff on all Chinese imports if he is elected for another term, and Europe is threatening its own set of punitive tariffs against Chinese imports.  

It has to be of concern to Chinese policymakers that the bursting of the country’s housing and credit market bubble is now raising the specter of deflation. In the second quarter of this year, the Chinese GDP deflator declined for the fifth consecutive quarter. That could have a dampening effect on consumer demand at the very time when China’s economy needs to reduce its over-reliance on the housing and export sectors of the economy. 

All of this could have major implications for US and world inflation. As the world’s largest consumer of commodities, a slowing Chinese economy is already exerting downward pressure on world oil and other internationally traded commodity prices. At the same time, China is likely to try to export its way out of its industrial overcapacity problem by engineering a weakening of its currency through interest rate cuts. 

When the Federal Reserve meets next week, we have to hope that it takes note of the deflationary forces coming out of China, the world’s second largest economy. Maybe then it will do the right thing and cut interest rates by 50, rather than 25, basis points to address the slowing now evident in the US economy and the loosening of domestic labor market conditions.

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