China’s Economic Engine is Out of Fuel and Netanyahu Makes Israeli Intentions Clear

What is the Largest Threat to the Chinese Economy?

Population decline is the largest structural threat to the economy. The set-up is reminiscent of the ‘Lost Decades’ in Japan. Japan’s peaking population coincided with more than a decade of deflation, which popped an asset bubble that has yet to fully recover. Japan’s Nikkei index peaked at ~38k in December 1989 and is finally nearing a new all-time high trading ~3% below the 1989 peak (Click for More on the Lost Decade). 

How Fast is the Population Shrinking and What is the Root Cause?

China announced its population shrank by more than two million people last year. China’s population is expected to shrink by 100+ million in the next 26 years and by 600+ million in 2100. The percentage of retired citizens requiring care as a percentage of the total population will increase too, an economic headwind. China’s ruling party is widely opposed to immigration and has faced negative net immigration since the People’s Republic of China (“PRC”) took control in 1949. Moreover, China’s birth rate is well below the replacement rate due to lasting effects of the government’s one-child policy. Despite reforms and the policy’s repeal in 2016, China’s birth rate has set a new low every year for more than three decades (Read More About Population Decline in China).

What Makes China’s Economy Particularly Sensitive to Population Shrink?

The declining population is particularly troublesome given China’s economic engine has been driven by the real estate sector; the sector’s success is predicated on incremental demand. Long-successful, domestic developers took on large debts to fund development projects. However, waning housing demand and asset values have real estate giants in trouble. Last week, China’s largest developer Evergrande began its liquidation process with more than $300 billion of debt owed. The situation threatens the stability of the Chinese financial system. Banks find themselves exposed to large loans backed by depreciating assets (Read More from the IMF).

What Are Other Factors Weighing on Economic Growth in China?

China posted its fourth consecutive deflationary month. Rising consumer savings rates should be expected to further weigh on demand because ~70% of individual wealth in China is held in real estate. China has high unemployment among its youngest adults. China’s status as the hub of cheap manufacturing is under threat due to the rise of Chinese wages and geopolitical risk. Also, China’s lack of differentiated products means China may face more intense global competition moving forward in commodity exports (metals, chemicals, etc.). South Asia, India, and Mexico have been eroding China’s dominance of the global supply chain. Rising tensions between the U.S. and China have expedited this trend. It’s unclear how China’s economy will turn the corner in the near term, as reflected in the Chinese stock market rout that has destroyed more than $7 trillion of value.

What are the Significant Takeaways from Netanyahu’s Address?  

The order in Netanyahu’s speech is key: “At the start of the war, I outlined three goals. 1. Destroy Hamas 2. Freeing the hostages…”

Israel has assessed the future national security risk of trading life for ceasing military operations and the risk of increased soldier casualties; they are unwilling to compromise. Netanyahu notes Israel’s ability to have quick and effective military success; pauses will be taken on an Israeli timeline as needed. Israel doesn’t want to threaten momentum in an operation that has already claimed the lives of 564 IDF soldiers. The conference was a statement to the world that Israel will not be influenced by global pressures. If rocket fire from Hezbollah continues, a second operation in Lebanon seems more likely than not.

What is Israel’s Next Phase in Gaza? How is Egypt Reacting and Why?

Israel made its near-term goal to enter Rafah clear since the speech. Hamas is threatening an Israeli assault on Hamas’ last stronghold in the South Gazan city of Rafah would “blow up” hostage exchange conversations. Israel is presumably unphased; it is likely taking an operational pause for strategic planning and objective setting before the IDF confronts Hamas in Rafah.

Egypt threatened to suspend the 1978 Camp David Accords if Israel conducts operations in Rafah. Egypt also increased its military presence on the Egypt-Gaza border. Rafah borders Egypt, which fears hundreds of thousands of Gazans would immigrate to Egypt. Mass migration could destabilize Egypt, which is already facing economic hardships. Egypt faces the largest economic consequence of the Red Sea disruption. Suez Canal revenues, rapidly declining, funded ~10% of Egypt’s national budget in 2023 (Read More About Egypt’s Response). 

How has U.S. Policy Shifted in the Middle East? What’s the New Approach for Peace?  

Iran’s strike on Tower 22 has shifted the American approach towards Middle Eastern safety and peace. U.S. policy is now nearly unanimous in the view Iran cannot be negotiated with. Sentiment Bibi shared in his speech; the U.S. likely believes they can help normalize Israeli-Saudi relations with the common threat of Iran.

U.S. Central Command reported continued strikes against Kata’ib Hezbollah in Iraq, killing a Commander; they also reported continued strikes on Houthi assets in Yemen. Fears of Iran provoking a regional war have abated. Iran has demonstrated its lack of appetite to initiate war off Iranian soil.

The open-ended operation in response to Tower 22 gives the U.S. justification to continuously erode the strength of Iranian back groups off Iranian soil; the approach takes advantage of Iran being a non-nuclear state. The strikes on Iranian-backed assets and leadership throughout Iraq and Syria may also serve to lighten Israel’s load against Hezbollah in the future. Israel has taken direct strikes against Iranian leadership off Iranian soil over the same period.