Anti-globalists and China bulls fiercely resist the concept that China can do a lot of any fallacious. And China is definitely higher led that the US and has had a merely extraordinary financial run. Nevertheless, China’s leaders, from Xi Jinpeng on down, are admitting to one thing they’d fiercely denied was taking place: that China’s reply to shifting its progress mannequin away from exports to extra dependence on funding, has hit its limits and is producing what within the US was as soon as referred to as “ruinous competitors.”
One signal has been deflationary tendencies, as confirmed by Chinese language traders, as we warned in January in China’s Authorities Bond Market Sounding Loud Deflationary Alarm. Is the Japanification China Has Warded Off Lastly Arriving?. There we additionally defined lengthy kind why deflation is extra harmful than inflation.
We defined earlier this month that the Chinese language authorities was not solely admitting to an overinvestment/overcapacity downside, but additionally shifting to implement insurance policies to deal with it. To provide a way of the magnitude:
China producer worth deflation intensifies. Now -3.6% YoY. No economist forecast that.
The message for the remainder of the world is evident. pic.twitter.com/3OUZ0LTNC8— PPG (@PPGMacro) July 9, 2025
China is bumping up in opposition to the “unimaginable trinity.” By selecting to not devalue in response to US tariffs, it can also’t ease financial coverage to counter rising deflationary strain. China has tied its fingers. Not devaluing means it chooses deflation…https://t.co/syJg8vmHpA pic.twitter.com/ukJBWHP4QH
— Robin Brooks (@robin_j_brooks) June 29, 2025
This isn’t the primary time China had has to cope with deflationary pressures; China had a bout from 2012 to 2016 and did flip it round. However as we defined, it largely exhausted the straightforward measures.
One factor that will not be evident from articles within the final day or so on the Chinese language economic system is that senior social gathering official, together with Xi, simply had a Politburo assembly at which they introduced new coverage measures, a few of which had been prefigured in earlier statements. New official initiatives take some planning and packaging, so these new campaigns have been already within the works. However instantly on the heels of their announcement was a contemporary information report that recommended that the overcapacity subject could also be much more extreme than acknowledged when the anti-deflation program was devised. We’ll flip first to the brand new data, on manufacturing facility exercise, after which return to what the Chinese language authorities intends to implement.
Let’s go first to the naked information of the newest improvement, that of an surprising fall in Chinese language manufacturing facility exercise. It might not sound that unhealthy on the floor, however we’ll peel the onion. From Bloomberg:
China’s manufacturing facility exercise unexpectedly deteriorated in July to a six-month low regardless of a tariff truce with the US, as early indicators emerge that exports are slowing and weak home demand persists.
The official manufacturing buying managers’ index (PMI) was 49.3, versus 49.7 in June, stated the Nationwide Bureau of Statistics (NBS) on July 31. The median estimate of economists surveyed by Bloomberg was 49.7. A studying under 50 signifies contraction…
The PMI figures are the primary official information out there every month to supply a snapshot of the well being of the Chinese language economic system….
That got here after the nation registered a document commerce surplus within the first half of the 12 months on hovering shipments to southeast Asia and stabilizing exports to the US.
However China’s resilience is dealing with headwinds. Cargo throughput on the nation’s ports final week was the bottom in virtually three months and dropped almost 7% from the earlier seven days, an indication commerce could also be beginning to sluggish…
Weak consumption may intensify deflationary pressures. A latest survey by the central financial institution discovered that Chinese language households grew to become extra pessimistic within the final quarter and their view of the roles market fell to its worst ever. That has fanned fears of a slowdown within the second half of the 12 months, even after a robust first six months of exercise exceeded the official annual enlargement goal of about 5 per cent.
The bottom manufacturing facility output stage in six months, within the summary, is a nothingburger. However this follows a interval early within the 12 months of US importers stockpiling items, which was considerably unwound within the later a part of the second quarter, and gave a raise to US GDP reviews. After which after the Liberation Day tariffs have been introduced, exports to Southeast Asia grew markedly. Needless to say regardless of all of the noise in regards to the commerce deficit with the US, its deficit with ASEAN is even bigger. Chinese language exports to Southeast Asia equally exceed these to the US or the EU. Admittedly, a few of these exports are transshipments to the US, and analysts opined that a variety of the second-quarter surge to Southeast Asia was a easy effort at circumvention. However Thailand no less than complained about China dumping merchandise, so there seems to have been some channel stuffing too. Thailand has additionally criticized its Chinese language factories as “zero greenback” operations, designed to supply as little as doable profit to the host nation and as a lot as doable to the Chinese language proprietor/operator.
Admittedly, skirting commerce guidelines will be onerous to detect, however US tariff threats in opposition to Southeast Asian nations have led to tightening in procedures. How a lot of a distinction they make in the long run remaind to be seen.
However, the important thing level is that the persevering with deterioration in manufacturing facility exercise got here in a six months with the next stage of exports to the US and Southeast Asia than is prone to be sustained going ahead.
Now let’s flip to the Politburo admissions that China certainly has an actual overcapacity downside and what the federal government intends to do about it. From Reuters:
China’s prime leaders have pledged to assist an economic system that’s dealing with numerous dangers, by managing what’s considered as disorderly competitors and beefing up capability cuts in key industries within the second half of the 12 months.
The official information company Xinhua stated on Wednesday that leaders have signalled they’ll rein in worth wars amongst producers, amid rising expectations that Beijing could also be about to begin a brand new spherical of manufacturing facility capability cuts in a long-awaited however difficult marketing campaign in opposition to deflation….
Analysts stated policymakers could really feel much less urgency to introduce new stimulus measures, as stronger than anticipated financial information and a continued tariff truce with Washington permit better give attention to supply-side measures to fight overcapacity and deflation.
And South China Morning Put up:
On the identical day [as the Politburo meeting], Xi held a symposium on the economic system with outstanding figures from outdoors the social gathering, stressing the necessity for stability and calling for efforts to spice up consumption and break away from harmful intra-industrial competitors – reiterating the feelings within the Politburo’s assertion….
Motion was urged [by the Politburo] to “regulate disorderly company competitors in accordance with legal guidelines and rules” and “advance capability governance in key industries”, a part of a broader push to fight neijuan – a time period referring to cutthroat competitors between companies that erodes earnings and fuels deflationary strain.
Native governments have been additionally instructed to control their promotional actions for funding, stop the accrual of latest hidden money owed and proceed to wash up native authorities financing autos – hybrid public-private entities used to bypass borrowing limits.
Channel Information Asia unpacked these developments in Why China is lastly beginning to acknowledge its overcapacity downside:
For years, Beijing dismissed Western issues about Chinese language overcapacity as protectionist rhetoric..
That narrative has now essentially shifted. In a exceptional coverage U-turn, China has not solely began acknowledging the overcapacity downside however is treating it as a nationwide precedence that requires pressing intervention….the clearest sign of this messaging transformation got here by means of lately on China’s personal coverage channels.
In July, the Communist Occasion’s main journal Qiushi warned that “disorderly competitors has destroyed complete trade ecology”. This wasn’t diplomatic language about market dynamics – it was an admission that harmful competitors had reached disaster proportions.
Across the similar time, President Xi Jinping chaired a gathering of the Central Monetary and Financial Affairs Fee, calling for “low-price competitors to be regulated” and outdated manufacturing capability to be “phased out in an orderly method.” Weeks later, the State Council explicitly linked “irrational competitors” to weak home financial circulation, naming high-profile sectors like new power autos as targets for speedy oversight….
The shift displays a sobering recognition that China’s industrial overcapacity has moved past an export downside to grow to be a home financial risk.
The price of some uncooked supplies has reached historic lows because of provide chain deflation, but manufacturing facility costs are being minimize even additional as producers interact in suicidal worth wars. The result’s unsustainable revenue margins which are forcing many producers to droop operations totally.
This deflationary spiral now threatens what Chinese language management calls the “whole-chain manufacturing mannequin” – the built-in manufacturing networks that Mr Xi lately reaffirmed as a nationwide precedence. When factories can’t function profitably, the complete industrial ecosystem turns into weak..
Importantly, China is just not utilizing the language of “overcapacity” that has dominated worldwide criticism. As an alternative, Beijing frames the issue as “worth wars” and “disorderly competitors”.
This distinction issues as a result of it permits Chinese language policymakers to deal with the underlying subject whereas avoiding the admission that their industrial coverage created systemic overproduction.
By specializing in pricing behaviour, China can place itself as selling honest competitors somewhat than acknowledging basic structural imbalances. This semantic shift allows coverage motion with out dropping face internationally or undermining confidence in China’s financial mannequin.
Nevertheless, the sensible impact could also be comparable. Whether or not addressed as overcapacity or predatory pricing, the answer requires lowering output, consolidating trade gamers, and restoring sustainable revenue margins throughout key sectors.
Be aware {that a} sector broadly considered as certainly one of China’s stellar successes, digital autos, is now a goal for rationalization. A contemporary story in OilPrice consists of one other one-time celebrated success, photo voltaic panels:
China’s undisputed management in electrical automobile gross sales and renewable power enlargement has come at a value for quite a few firms which have been working a race to the underside lately.
The surge in EVs and photo voltaic and wind energy installations has resulted in extreme manufacturing capability in these key clear power industries, igniting worth wars which have harm most firms within the cleantech sector, together with the largest photo voltaic panel producers.
Chinese language authorities realized final 12 months that cutthroat competitors, overcapacity, and low-quality manufacturing are hurting enterprises.
Overcapacity has been a persistent subject in China’s clear expertise industries, undermining the profitability of photo voltaic panel and EV producers….
The manufacturing increase and the competitors for market share have prompted some Chinese language producers to sacrifice high quality for the sake of upper earnings. Firms wish to survive within the race to the underside in China’s photo voltaic element market, and a few are skimping on high quality and testing.
The Chinese language photo voltaic panel market stays oversupplied, and this glut may last as long as two extra years, one of many prime producers, Longi Inexperienced Vitality Expertise, stated final 12 months….
Within the EV market, “fierce competitors amongst EV and battery producers in China for state-based incentives has led to a pointy decline in EV and battery costs, serving to scale deployment, however has led to large overcapacity in batteries,” analysis agency Rhodium Group stated in a report final month.
At present, China’s battery manufacturing capability is 2 instances the demand in China and 1.2 instances international demand, in accordance with Rhodium Group.
Going after high-fliers received’t be simple. As Channel Information Asia provides:
However significant motion faces important obstacles. Native governments have robust incentives to guard regional champions, usually providing subsidies to take care of employment and financial output. Provincial leaders compete to draw funding in precedence sectors like synthetic intelligence, electrical autos and semiconductors – creating the very fragmentation that fuels harmful competitors.
Recall that China had shifted its progress technique away from housing as a major driver to funding in high-tech industries. There’s nonetheless a deflationary overhang in property; though costs will not be an excessive amount of out of line in Beijing and Shanghai, they’re nonetheless reportedly elevated in many of the remainder of the nation. That persevering with unwind will make it onerous to get shoppers to spend extra, for the reason that lack of wealth tends to guide households to save lots of extra to attempt to restore their funds.
In different phrases, rectifying this example is so much tougher than it might sound. China could lastly have run into Stein’s Legislation: “If One thing Can not Go on Perpetually, It Will Cease.“