China’s Economic Achilles’ Heel

V ladimir Putin’s Russia is currently learning the hard way about the devastating economic costs of the Ukrainian invasion spearheaded by its leader. Before offering Russia support in its war effort, Chinese president Xi Jinping would do well to heed these economic lessons. With all of China’s present economic weaknesses, the last thing that the Chinese economy needs now is U.S. sanctions on its exports — which support for Russia’s war would almost certainly invite.

In waging his war with Ukraine, Mr. Putin likely did not expect a unified Western economic counter-response. Perhaps he thought that the $630 billion war chest of international reserves he had built up would be sufficient to insulate the Russian economy from any Western sanctions.

In the event, that assumption proved to have been mistaken. Not only did the Western countries succeed in excluding many Russian banks from the SWIFT payment system and cutting Russia off from key import components. They also succeeded in freezing around half of Russia’s international reserves.

There is every sign now that the Russian economy is on the cusp of a major recession. The ruble has lost around half of its value, the central bank has doubled interest rates to 20 percent, the Russian government has had to impose capital controls to stem capital flight, and Russia appears close to a debt default. Considering each of these, JPMorgan has recently predicted that this year the Russian economy will contract by more than 12 percent.

Fast-forward to China. Even before the Russian invasion, China’s economic troubles seemed to be coming not as single spies but in battalions. As underlined by Evergrande’s problems in repaying its debt, the Chinese property and credit-market bubble seemed to have started unraveling. At the same time, the country’s tech sector was being hit hard by new government-imposed regulations while the country’s no-tolerance Covid response was resulting in the renewed locking down of a number of key industrial sectors.

In the wake of the Russian invasion, international oil, food, and metal prices have gone through the roof. Among the countries that will be hardest hit by the Russian commodity-price shock will be China, the world’s largest commodity importer.

The Chinese government recognizes that, among many economic demands, it must wean itself from its currently unsustainable property and credit-led economic-growth model. That model has resulted in the Chinese property sector’s having grown to some 30 percent of the Chinese economy or almost double the corresponding U.S. ratio. It has also led to a situation in which housing prices in relation to income in key Chinese cities is considerably higher than those in London and New York.

It is against this backdrop that the Chinese economy can ill afford to have any further slowing in economic growth if it is to have any hope of growing itself out from under its property and credit-market bubble. Yet that is precisely what would happen if there were to be a U.S.-led intensification of trade sanctions against China. This is not least because China is a relatively open economy whose exports amount to close to 20 percent of total GDP.

From a purely economic perspective, we must hope for both our and China’s sake that President Xi has the good sense to stay out of the Russian–Ukraine war so as not to invite U.S.-led trade sanctions. At a time when we are struggling with our own decades-long high inflation rate, we can ill afford to have a stuttering of the world’s second-largest economy or to have further supply-chain interruptions that a China–U.S. trade war would bring in its wake.