09 Jul SITREP: And by the way, how are things in China?
By,
Octavio Perez, Senior Fellow | MSI2
Sometimes, we never care to ask about a relative, or neighbor, or, in this case, people on the other side of the world.
So, with that thought, as the world is in turmoil in the Middle East, Ukraine, and Russia, we often forget there are issues elsewhere. We only respond to natural disasters, accidents, and significant market issues when they happen. When in fact, we forget what other real problems are eroding the foundations of a nation, its economy, and people.
We have vast misconceptions about how big a country may be, how strong its economy is, and obviously, its military power. But sometimes it is good to read about real indexes, real foundation, and long-term considerations.
In the last few days, I came across three articles on China that revealed fissures and cracks in the great Jade Lion or Dragon, which show the real underlying issues within the state and its economy. In Spanish and English, we use the word sincere/sincera as a truthful, honest affirmation of what it should be. Still, the root Latin word comes back, from when Marble statues, sculptures, and busts were sold, you asked if they were sin cera (without wax), a common practice to cover fissures in marble and somewhat undetectable to many.
Well, these articles do remove the wax and show the real fissures and issues China is currently facing, but few take the time to read or analyze them to comprehend the nation’s real endurance or prospective future.
The first article has to do with government misappropriation at local governments. Coincidentally, we just had one of the biggest busts of Medicaid Fraud these days in the US, but what happened in China is rampant and out of control, according to China Economic Review.
China’s outreach as a bank, developer, and granting funds to third world countries is also significant. As we saw in the recent spat between Pakistan and India, It subsidizes loans. And renegotiate terms with these countries who are in need to adjust credits with the IMF and other world organizations.
“…China’s local governments misappropriated billions in pension funds…”
The funds from the basic funds have been diverted to pay for:
- Debt repayment
- Repayment of the three guarantees
- Basic livelihood
- Public sector wages
- Essential government operations
Nationwide, the (NAO) National Audit Office found that 4.1Trillion RMB, that is $576.9 billion, have been improperly transferred to cover other needs.
“…The most serious case involved the misappropriation of around RMB 40.6 billion in basic pension funds across 13 regions…”
And for those who think tariffs don’t work… Nike will cut China footwear output to counter the tariff hit. Nike is undertaking a major overhaul of its global supply chain to reduce its reliance on Chinese manufacturing for footwear destined for the US market. The move comes as the sportswear giant faces mounting tariff pressures and falling sales, reports
- China produces around 16% of the NIKE footwear sold in the US
- Trump tariffs will add over a billion dollars in expenses
- Retail footwear sales in China are sluggish
China plays another role as the creditor and owner of foreign debt. Brings Pakistan closer as it rolls over Pakistan loans
- China has rolled over $3.4 billion in loans to Pakistan, two senior Pakistani government officials told Reuters on Sunday, in a move that will help boost Islamabad’s foreign exchange reserves
- Beijing rolled over $2.1 billion, which has been in Pakistan’s central bank’s reserves for the last three years
- and refinanced another $1.3 billion commercial loan, which Islamabad had paid back two months ago.
China’s June factory activity decline eases.
- China’s factory activity improved for a second month but remained in contraction, as trade rebounds
- The official manufacturing purchasing managers’ index was 49.7 in June, versus 49.5 in the previous month, slightly exceeding the median estimate
These are their conclusions:
The article posted by China Economic Review points out the following:
“…The clearest message is a confirmation of the fact that many of China’s local governments are in bad financial shape and are having to dip into the longer-term focused pension funds to pay off more urgent requirements.”
Independent of the fact that the numbers provided by the NAO are actual and do reflect the real country-wide picture. Finding in 13 regions would.
China’s lack of a comprehensive social safety net, within which pension funds play a major role, is also a key part of the country’s current consumer confidence struggles. And these findings are likely to decrease confidence both overall and in local governments’ ability to pay out pensions when they come due.
Nothing is holy in China, or elsewhere in the world. Pension funds have been used as piggy banks to subsidize other government shortfalls. But when there is a national level lack of consciousness of their role and reason, there will be more propensity to misappropriate.
If you don’t understand that the workforce is getting older, and that no other retirement options apart from the state exist, it will be a crisis. When the central government does an audit at this level. How can it rectify the shortages?
The second article had to do with Xi Jinping’s absence between May 21st and June 5th… Anytime this happens in China, it could very well be a purge, a reshuffle of cabinet members, or major changes are coming.
The article alludes to Xi Jinping’s eroding ideological control. And as consequence of it allude to the grooming of another leader; Wang Yang. Just 14 days in the later part of May and the beginning of June created enough concern. In the case of Xi Jinping, he has used these periods to purge either government or military leaders. This was and has been a common practice of the CCP (Chinese Communist Party) with major leadership changes.
Despite keeping his titles, the CCP sidelines the outgoing leader and starts the cycle with the groomed candidate. Intelligence sources claim there is evidence of this since several Army generals linked to him have been removed.
China’s economy is struggling with:
- 15 per cent youth unemployment and stagnant real estate growth.
- Failures in semiconductor funding programs further compound the economic woes.
And yes, here we go again, just like Argentina went to war with England over the Falklands in 1982, while in the middle of internal instability, China has also shown times when attempts to reshuffle leadership have led to scrimmages with India. Even more amongst generals in the Western Theater Command who want to prove their loyalty. History shows examples back in:
- South China Sea 2012
- In 2014, during the anti-corruption crackdowns that impacted Army leaders and local power figures
- The Bo Xilai crisis in 2020, where confrontations in Ladakh occurred
Internal problems in China do matter, and how they project themselves elsewhere, as the second largest economy of the world, everyone should keep an ear to the ground to monitor potential issues.
China’s way of doing business is extremely complicated; it depends on a trade surplus of over a trillion dollars in order to keep a 5% growth rate. As the world now turns into a protectionist environment, trying to wean itself off critical medical, communications, and other key strategic manufacturing that has migrated towards China. Demand for its products is not on an uptick. Manufacturers like Tesla and Apple are opening production in India, back in the US proper, and other more favorable markets.
2024 was a year where export prices fell, and as we traverse July of 2025, the trend continues.
Even worse, consumer prices in China have fallen since February 2025. The tariff wars and a weaker dollar contribute to this.
And finally, the third article by Alicia García-Herrero, who lays out the 10 economic challenges China must face to get its economy back in an upswing…
Alicia makes a succinct analysis of what the economic policy decision makers must do to deal with deceleration of their economy.
Challenge 1: Hardly any fiscal room
She addresses the same issues in the first article about the misappropriation of retirement funds. As she reiterates:
“…China’s growing public debt stems from huge fiscal deficits, especially when the total local government borrowing is taken into account, including that generated through special vehicles widely used to finance real estate and infrastructure projects…”
Challenge 2: Monetary policy constraints
China long had monetary policy headroom, especially after developed economies, in particular, introduced ultra-lax monetary policies in response to the COVID-19 pandemic in 2020. With deflation and the slowing down of the economy, it curtails and closes the gaps for action.
- First, the rather weak renminbi leaves less room for the PBoC to ease monetary policy.
- Second, Chinese banks, already suffering from very poor profitability, would find it difficult to bear an even lower net interest margin stemming from further rate cuts.
Challenge 3: Domestic demand
China continues to produce well beyond what it can sell domestically, and add to that the collapse of the real estate market.
AI searches on Google reveal that between 65 million to 90 million empty homes/apartments are vacant. A significant glut and product of a boom to buy a home as an instrument of equity investment has led to this.
India surpassed China in April 2023 in population, whereas China’s population is getting older.
Another AI search reveals: “…Its population has decreased for three consecutive years, and the birth rate has also declined, leading to a shrinking workforce and an increasing proportion of elderly individuals. This trend is expected to continue, with projections indicating a substantial population decrease by mid-century…”
On the other hand, China has embraced Green Technology, which leads the world with almost 90% of manufacture and sales of solar panels.
So, with these impulsive pursuits of controlling a market share within an industry, what can happen when demand falls?
Challenge 4: External demand and geopolitical challenges
The good news for China is that the world has accommodated even more Chinese exports since the COVID-19 pandemic. Chinese imports have been stagnant, so this has meant a very large trade surplus, which has been crucial for growth
- Tariffs wars
- Resurgence of manufacturing protectionism
- Weaning off dependency on Chinese products by key buyers (US, UK)
China did achieve up to 18% of the global market share worldwide by 2021, but sustaining this going forward will be a challenge. The only saving factor has been:
- The EU and the emerging world have seen increases (notwithstanding EU tariffs on Chinese electric vehicles).
- China’s massive industrial capacity can continue to rely on foreign markets as much as in the past.
Challenge 5: Overcapacity and deflationary pressures
Despite the rest of the world importing from it, China’s industrial capacity is simply too much to absorb. China’s capacity utilisation rate has dropped from a peak in 2021 and is close to the levels seen during the pandemic (though still higher than during China’s worst episode of overcapacity in 2015
- Utilisation might not be the best measure of China’s overcapacity, since it is comparable to that of the US
- Plummeting producer prices are a signal of the problem, putting downward pressure on companies’ margins
- Proliferating protectionism can only worsen deflationary pressures in China unless China can foster domestic consumption.
Alicia’s analysis is on spot, too many internal factors in play, the Chinese economy is a Rubik’s Cube, requiring multiple adjustment all intertwined and dependent of each other.
Challenge 6: Stubbornly low private consumption without policy support
There is general agreement that increasing private consumption would help resolve China’s imbalances, but it is easier said than done:
- The ratio of Chinese private consumption to GDP remains stubbornly low, especially compared to fixed-asset investment.
- While investment is too high, domestic savings are even higher. China continues to have the world’s highest savings ratio
- All this as a response to the lack of a welfare state, but also very few private saving opportunities.
Changing this would require major reform, such as strengthening the pension system and offering unemployment benefits and public healthcare.
- None of these reforms seems to be on the government agenda.
- President Xi Jinping has expressed his reservations about a welfare-state-based model, which he dubs “welfarism
Alicia reiterates the Specter of major reforms, which is part of the Chinese culture. We forget that it’s origin as a patriarchal society, where the father, grandfather, the clan, and the family take care of themselves. A welfare state, depending on very few investment tools that the government could tax you, is not convincing enough.
Challenge 7: Real estate still contributing to asset price deflation
China’s real estate sector, long the main source of growth (one-third of the total and also one-third of fixed-asset investment), burst in 2021 when China’s largest developer, Evergrande, defaulted.
- Since then, the contribution of real estate to growth has been negative (it was already very low)
- House prices and real estate transactions have been falling for years
To Alicia’s point: real estate is not seen as an investment, and given the building glut, prices continue to fall, unlike an American having bought an apartment in Chinatown, Washington DC, in the 1990s and selling it in 2025 and making 100-fold.
Challenge 8: Over-investment at the cost of increasingly low returns
China’s high savings have fed the huge investment boom. This boom certainly helped China grow very rapidly.
- But it has remained the main source of growth for too long, ultimately becoming excessive, as shown clearly in increasingly low returns
- Returns on assets are lower for state-owned enterprises (SOEs), as one would expect, but also for privately-owned enterprises (POEs)
The story repeats itself, over and over. People tend to take care of themselves, don’t trust the government to be there for them, so you’d rather have money on the mattress or a can than deposit it for a low yield and no need to buy an apartment or house.
Challenge 9: Shrinking population
China is an outlier in terms of the speed at which the population has aged. The introduction of the One Child Policy in 1980 explains China’s difficult demographics, but the fertility rate has also fallen rapidly since 2019, possibly because of the much more uncertain environment, leading to a negative sentiment about future economic prospects.
Even if China’s population has already peaked and the labour force is declining, the actual contribution of the labour force to GDP growth should remain positive as long as China continues to urbanise.
The urbanisation process is estimated to be completed by 2035, which is when the decline in the labour force will also start to be felt in the cities, negatively impacting productivity and shaving off about 1.3 percentage points of growth each year.
Once again, Alicia does bring up a critical factor we have seen in Germany, Japan, and will probably see in Ukraine in the future, and due to the reasons she eloquently exposes in her article. World War II, the one-child policy, and the abstinence of the younger generations have led to this dilemma, which is affecting the next generation (30 years).
Challenge 10: US technological containment
China competes with the US on innovation. The US outstrips China on spending on research and development as a percentage of GDP, which means that it will not be easy for China to bypass the US’s global technological dominance. Furthermore, the US has sought to contain China’s technological advances through different means, including export controls on advanced technology.
The questions remain of whether the US will succeed in containing China, and whether China’s push for innovation will help increase its total factor productivity or, in other words, help mitigate structural deceleration.
China is investing in all technologies, increasing their scope in every technological realm Space (Moon station, mission to Mars, Satellite networks, Space Energy Systems (solar station); has the largest fiber optic cable laying fleet, has the only fiber optic cable cutting system. Dominates in green energy production of batteries, and vehicles. Needless to say, exploration and exploitation of strategic minerals.
And still, it does not lead the US in technology development. It follows galloping towards it.
Conclusions
Just reading three articles at random written in a timeframe of June 12 through July 01st, you get a current vital sign of the Chinese economy and state. Although the problems have been known for years, the challenges remain and even get worse.
From the time Donald Trump came back in on his second term, China has been countering with measures to stabilize the economy and keep the goal of a 5% growth rate for 2025.
The path that they have chosen to continue pushing for more industrial capacity without incentivizing national consumption and purchases will not help. The decision to get into a welfare state model, controlled and funded, would help, but its leadership still does not take the right steps, and very little would be expected.
References
China Economic Review. (2025, June 30). China’s local governments misappropriated billions in pension funds…Nike to cut China footwear output to counter tariff hit…Xiaomi SUV bookings reach 240,000. China Economic Review. Retrieved from https://chinaeconomicreview.substack.com/p/chinas-local-governments-misappropriated?utm_campaign=email-half-post&r=5qpmj4&utm_source=substack&utm_medium=email
Gupta, M. (2025, July 1). Xi Jinping’s absence signals power shift? Intel sources warn China’s internal turmoil may spill over to LAC. News18. Retrieved from https://www.news18.com/world/xi-jinping-absence-signals-power-shift-sources-warn-china-turmoil-may-spill-to-lac-ws-dl-9412181.html
Herrero, A. G. (2025, June 12). Ten challenges facing China’s economy (China’s economic problems are structural; the response so far has not tackled the root causes). Bruegel.org. Retrieved from https://www.bruegel.org/analysis/ten-challenges-facing-chinas-economy
The opinions expressed in this article are those of the author and do not necessarily reflect the views of the Miami Strategic Intelligence Institute (MSI²).