Unraveling the Mystery: Why China's Stock Market Defies Economic Reality | Digging into China

Hi, I'm Dong Xiong. Welcome to Digging into China, where we explore China in-depth to reveal unique perspectives. Recently, China's stock markets have experienced an unexpected surge. Both the Shanghai Index in mainland China and the stock indices in Hong Kong have risen to varying degrees. This phenomenon is intriguing because the broader economic data, particularly domestic consumption in China, shows no significant improvement. Furthermore, there has been no major positive development within the Chinese economy itself. In this context, the stock market's unusual rise contrasts sharply with the ongoing decline of the real economy. This contradiction raises a critical question, what is driving this anomaly? Concurrently, another development has drawn considerable attention. It appears that China and the United States have reached a trade agreement, with China signaling a notable soft stance, suggesting a renewed openness and willingness to compromise with the U.S. At the same time, rumors have surfaced that Xi Jinping's authority is waning, with some even speculating about his potential departure from power. Could there be a hidden connection between these political rumors and the stock market's irrational surge? Let us explore this question today. We begin by examining the evolving relationship between the U.S. and China. In late June, the U.S. Treasury Secretary announced that Washington and Beijing had signed a trade agreement, allowing China to ease certain restrictions and enabling the U.S. to import magnets and rare earths from China. China's Ministry of Commerce confirmed this trade agreement framework, noting that the U.S. would in turn lift specific restrictions on Beijing. At a White House event, President Donald Trump addressed the media with confidence, stating that he had secured a deal with China that was highly advantageous for the U.S. Many observers interpret this as the U.S. using assertive measures to compel China to make economic concessions. Previously, China maintained a resolute stance, but it now appears to be softening. Meanwhile, the U.S. attitude toward China is growing increasingly firm. Recent reports from outlets such as Newsweek and CNN have revisited an old claim that Trump once directly warned Putin and Xi Jinping against reckless actions or initiating conflicts with neighboring countries, threatening military action against Moscow and Beijing if they did. While this is an older story, its re-emergence in U.S. media referencing the notion of bombing Beijing and Moscow indirectly conveys a tougher posture, one that could escalate to military confrontation. Economically, the U.S. continues to intensify its efforts to contain China, building on the foundation of the trade war. Recently, Trump announced tariff standards targeting several Asian nations. An analysis in The Economic Economist suggests that these tariffs, at their core, are still aimed at China. It is well known that despite U.S. tariffs on China, China can export components to third countries for assembly, then sell the finished products to U.S., effectively bypassing tariffs. By imposing tariffs on these third countries, Trump aims to close this loophole, with Vietnam being a notable example. To avoid high tariffs or U.S. penalties, these third countries must negotiate directly with the U.S. and commit to ceasing covert dealings with China. Amid this external pressure, internal changes seem to be unfolding in China, particularly at the highest levels. According to media reports, China's leadership has decided to establish a central decision-making and coordination body, which is believed to be intended to distribute some of the supreme leader's authority. Hong Kong's official English-language outlet, the South China Morning Post, published an article indicating that China's top leader will delegate more power to subordinate party representatives. This suggests a move toward decentralization. While numerous online rumors circulate about this, their veracity remains uncertain. However, based on verified facts, it is evident that a power adjustment is occurring at China's highest levels. Given the current international pressures, Xi Jinping's absolute authority may be facing challenges, though the future trajectory remains unclear. In other words, China is at a pivotal moment of political and economic transformation, but it is uncertain whether this will lead to positive outcomes. The previously unshakable structure of Xi Jinping's leadership appears to be loosening. What logical connection exists between this political environment and China's economic and stock market trends? From a macro perspective, economic theory suggests that after reaching middle-income status, an economy naturally slows down. This is a normal phenomenon and not attributable to Xi Jinping. However, China's economy is not merely decelerating, it is experiencing a precipitous free-fall decline. A significant factor in this rapid downturn is the deterioration of U.S.-China relations under Xi Jinping's leadership, for which he bears considerable responsibility. In essence, the greater Xi Jinping's authority, the worse U.S.-China relations become, leading to poorer performance in China's market economy and a bearish outlook for the economy. Conversely, the more constraints placed on Xi's power, the more reason there is to be optimistic about China's economic prospects. This is a straightforward economic deduction. Recently, we have observed a recovery in both the Shanghai and Hong Kong stock markets, coinciding roughly with the spread of rumors about the limits on Xi Jinping's power. From a broader perspective, this aligns with the logic outlined earlier. If a financial institution were to create a Xi Jinping index, it would function as a bearish indicator for China, akin to the U.S. VIX, a measure of market risk. When the VIX rises, the stock indices tend to fall. Similarly, a high Xi Jinping index would correlate with lower Chinese stock indices, while a lower Xi index would correspond to higher stock indices. In this sense, Xi Jinping himself serves as an index, the most effective market risk indicator for China. From this macro perspective, the recent subtle shifts in China's stock market can be understood. However, this interpretation lacks granular detail, and the reality is far more complex. If a Xi Jinping power index existed, we might observe it trending downward. But does this signal a long-term trend? Does it mean Xi Jinping will lose power? I believe that is far from certain. Moreover, a decline in this index does not necessarily correlate with China's long-term economic development. More critically, what explains the abnormal rise in China's stock indices? What are stock traders doing? Rather than betting on China's economic growth, it is more accurate to say they are wagering against Xi Jinping's authority. This bullish sentiment is short-term and emotionally driven, lacking a sustainable foundation in the long term. In the long term, China's economy continues to face an unclear growth trajectory. Let us examine this issue further. The superficial rise in stock indices can be entirely attributed to monetary and credit expansion. Recent Chinese data clearly supports the rise in financial indices. For example, total social financing data has begun to rebound with year-on-year growth approaching 9%. The gap between M1 and M2 growth rates is also narrowing. Additionally, the Chinese government has resistantly lowered interest rates, reduced banks' reserve requirements, and implemented policies to cut rates and inject liquidity, further elevating financial indices like the stock market. Recently, China has also engaged in aggressive reverse repo operations, lending funds against bond collateral to increase liquidity. China's liquidity data is fully controlled by the central government, and these figures can be manipulated. Consequently, surface-level data does not reflect the true state of the Chinese economy. Reliable direct data is scarce because much of it is either not collected or not disclosed. For instance, the official urban unemployment rate is reported at 5%, but few believe this is accurate. The actual operating conditions of Chinese business are also not publicly disclosed, leaving us to infer the situation from peripheral data. One useful peripheral indicator is the operational efficiency of large Chinese companies, which is notably low. In the Fortune 500 list, the U.S. has 130 companies while China has 133. U.S. companies achieve profit margins exceeding 8%, while China's are roughly half that, around 4%. These figures pertain to prominent listed companies. For small and medium-sized enterprises, achieving even 4% profit margin is unrealistic. Survival itself is a struggle. This explains why private research indicates that the average lifespan of Chinese enterprises is extremely short. Statistics show that Japan has over 25,000 companies over a century old, leading globally, followed by the U.S. and Germany. The average lifespan of Japanese companies is 52 years, and in the U.S. it is 24 years. In China, it is at most 3 years. This brevity is directly linked to businesses' inability to generate profits, which also accounts for China's high unofficial unemployment rate. The challenging environment for Chinese companies indirectly reveals significant pressure and instability in private sector employment. China's PPI, Producer Price Index, which has been negative since 2022, further illustrates this. The PPI reflects factory gate prices. Negative growth indicates falling prices, shrinking profit margins, and declining corporate profits. China's three consecutive years of negative PPI growth is a hallmark of deflation and economic stagnation. This deflationary trend is also evident in the GDP deflator, which measures real GDP growth after adjusting for price changes. China's GDP deflator has declined for nine consecutive quarters, the longest continuous decline since data publication began in 1993. This indicates that China is entrenched in long-term deflationary stagnation, with little prospect of escape. Currently, China's central bank continues to inject liquidity while PPI remains low, and the economy is mired in deflation. In other words, the real economy is languishing, yet the government is aggressively flooding the market with money. In this environment, excess funds do not flow into productive sectors, but into financial and virtual economies, potentially inflating bubbles and risking financial turbulence. Funds chase speculative virtual concepts like artificial intelligence, crypto-currencies, or stablecoins to drive stock prices. These concepts do not directly impact PPI or CPI, making it easier to craft narratives around them without verifiable data to challenge the hype. Speculating on these concept stocks is far simpler than investing in real industries. To summarize, the stock indices in mainland China and Hong Kong have experienced a sustained multi-quarter crisis, driven by the Chinese government's massive liquidity injections and aggressive monetary expansion. However, the underlying reality of China's economy is deflation, as evidenced by indicators like PPI and GDP deflator. China's economic reality and its stock indices are moving in opposite directions, indicating a degree of froth in the financial markets. While China's stock indices have not surged dramatically, even this modest increase contains bubbles, underscoring the severity of China's economic challenges. In this context, China is using overseas media and other channels to disseminate news of Xi Jinping's reduced power, suggesting that market openness will improve in the future. This fosters positive market expectations. But key questions remain, had Xi Jinping's power truly been curtailed, will China genuinely pursue greater market openness? Even if we assume Xi Jinping steps down, will China's business environment permanently improve? Would China become a modern, rule-based nation? I believe the answer to these questions is no. First, if Xi Jinping's power is diminished, he is likely to retaliate, much like Mao Zedong did when his authority was challenged, launching the Cultural Revolution. Xi's methods of counteraction are unknown, perhaps internal power struggles or even military conflict. These would pose real risks, destabilizing the economy and the markets. Thus, power reshuffling or turmoil is not necessarily positive for the market. Even in the most extreme scenario where Xi Jinping and his faction are entirely removed, would China's business environment permanently improve? Would China become a nation that respects legal frameworks, markets, and entrepreneurs? The answer remains no. A common phrase used to describe infighting among adversaries is dog-eat-dog. If we liken the Communist Party's power struggles to dog-eat-dog, even if Xi Jinping, one dog, is defeated, the newer leader will still be a dog. The outcome of such a struggle will still be a regime led by dogs, not humans. A nation governed by dogs. To be candid, as long as China's demographic structure, cultural beliefs, and society remains unchanged, the outcome of internal power struggles will not alter the country's fundamental nature. But it will remain a nation that disregards markets, economic principles, and legal institutions. Regardless of the results of internal power struggles, no substantive change will occur, and such a nation is inherently unfriendly to the economy and markets. The sole purpose of this current wave of stock market gains is to enable China's financial elite and certain power brokers seeking to exit, to cash out and flee. They are leveraging Hong Kong's financial markets, fabricated positive news, and self-generated financial bubbles to exploit investors and escape. Given the unsustainability of China's economic future, this speculative wave will soon subside. The stock market will rise briefly before declining again. Only the naive or opportunistic would remain bullish on China's stock market and economy in the long term, ultimately left holding overvalued assets. In essence, this is a large-scale scheme to exploit investors. China's financial elite, in collusion with certain power brokers, are disseminating a mix of truth and fiction to entice investors to take the bait. In reality, they are cashing out at the peak and fleeing. Realistically, how could China's economy rebound in the short term? From a macro perspective, the decline of Chinese politics, economy, society, and even its people is a decades-long trend that cannot reverse quickly. Any claims of an imminent recovery at this stage are misleading and part of a manipulative scheme to exploit investors. A word of caution. In the coming period, China will frequently experience short-term positive developments used to briefly prop up the stock market and exploit investors. Why does this pattern persist? Because China's market has transformed from the world's factory and construction hub into the world's largest black market for money laundering. In the time ahead, the stories of money laundering in China and Hong Kong will be both captivating and revealing. As observers, we can continue to watch this unfolding drama of China's grand money laundering saga. Thank you so much for watching. If you find this video helpful, please like it, drop a comment below, and hit the subscribe button right here. It really helps YouTube suggest my videos to others. I'll be back with more content soon. Until then, be well.