Investors are increasingly concerned that China risks sliding into an economic malaise that could last decades.
Investors in China’s $11 trillion government bond market have never been so pessimistic about the world’s second-largest economy, with some now piling into bets on a deflationary spiral mirroring Japan’s in the 1990s.
Yields on Chinese sovereign bonds maturing in 10 years have tumbled in recent weeks to all-time lows, creating an unprecedented 300-basis-point gap with US peers, despite a slew of economic stimulus measures announced by President Xi Jinping’s government.
The plunge, which has dragged Chinese yields far below levels reached during the 2008 global financial crisis and the Covid pandemic, underscores growing concern that policymakers will fail to stop China from sliding into an economic malaise that could last decades.
If the bond market is right, the implications would be profound. An extended bout of deflation would hobble one of the world’s biggest economic growth engines, add new strains on social stability in the second-most populous country and exacerbate capital outflows that led to a record exodus from Chinese financial markets at the end of last year.
In a sign of how seriously investors are taking the risk of Japanification, China’s 10 largest brokerages have all produced research on the neighboring country’s lost decades. Richard Koo, an economist well-known for drawing parallels between the two countries, said he has been approached by Chinese companies and think tanks to share his views. Goldman Sachs Group Inc. this week said Japan’s case offers a “valuable playbook” for Chinese stock investors who’ve been rattled by the worst start to a year in nearly a decade.
While an echo of post-bubble Japan is far from certain, the similarities are hard to ignore. Both countries suffered from a real estate crash, weak private investment, tepid consumption, a massive debt overhang and a rapidly aging population. Even investors who point to China’s tighter control over the economy as a reason for optimism worry that officials have been slow to act more forcefully. One clear lesson from Japan: Reviving growth becomes increasingly difficult the longer authorities wait to stamp out pessimism among investors, consumers and businesses.
“It’s a downward spiral that will keep getting worse if it’s not corrected,” said Xin-Yao Ng, a Singapore-based investment director at abrdn Plc, which oversees $494 billion globally. “There’s a psychological element to Japan’s lessons where the longer this persists, the weaker business and consumer confidence gets.”
China’s markets have entered 2025 on a knife edge. With the benchmark 10-year yield falling below 1.6% for the first time, pundits have floated the once-unthinkable prospect of yields near zero. The CSI 300 Index of equities lost 3.5% in the first four sessions of the year, while the offshore yuan is trading near a record low — prompting authorities to push back against declines this week. China Bond Yields Tumble
Its 30-year sovereign bond yield has fallen below Japan's
Source: Bloomberg
“The bond market is already telling the Chinese people: ‘you are in balance sheet recession’,” said Koo, chief economist at Nomura Research Institute. The term, popularized by Koo as a way to explain Japan’s long struggle with deflation, occurs when a large number of firms and households reduce debt and increase their savings at the same time, leading to a rapid decline in economic activity.
It’s not that Chinese authorities haven’t taken action. A sweeping stimulus package rolled out since late September has given the struggling economy a lifeline, with President Xi confident the country has met its around 5% growth target for 2024. For this year, top officials have vowed bigger fiscal spending and made boosting domestic demand a top priority. Some say the economic slowdown is a necessity for China to transform into an advanced economy driven by high-tech industries, away from the debt-fueled model of the past.
The problem is that the policy prescriptions so far haven’t been nearly ambitious enough to reverse falling prices, with weak consumer confidence, a property crisis, an uncertain business environment combining to suppress inflation. Data due Thursday will likely show consumer price growth remained near zero in December while producer prices continued to slide. The GDP deflator — the broadest measure of prices across the economy — is in its longest deflationary streak this century.
To be sure, not everyone accepts the balance sheet warning, pointing to the big differences between China today and Japan during the late 1990s, particularly China’s lower average income — which gives it more room for growth.
Lower spending by households and corporations suggests only a “partial balance-sheet recession” in China, said Wang Yingrui, an economist at AXA Investment Managers. She said the spending power of the central government is helping paper over the cracks, at least for now.
The accumulation of stimulus and a possible bottoming out of the housing market could see the economy rebound in 2026, according to David Qu, an economist for Bloomberg Economics. The property sector’s drag on the economy may ease while new industries including electric vehicles will be playing a bigger role, he added. Japan’s Warning
Regardless of one’s views, Japan’s fate during the lost decades between 1990 and 2010 offers a stark warning for investors in Chinese assets.
The Nikkei 225 index lost more than 70% of its value over that period, compounding the pain of banks and companies as debt-to-equity levels ballooned. It took the benchmark more than 30 years to reclaim its 1989 peak, a feat achieved last year only after a lengthy period of extraordinary monetary stimulus, a paradigm shift in corporate governance, and a long-awaited revival in inflation.
The yield on 10-year Japanese government bonds peaked at above 8% in 1990, before embarking on a prolonged slide to below zero in the mid-2010s. It currently trades at around 1%. Ultra-low yields are a hallmark of deflation as investors bet central banks will keep interest rates low to revive domestic demand.
China’s markets have gone in the same direction. Its 10-year bond yield, which stood just shy of 5% in 2013, slipped below 1.6% on Monday. The CSI 300 Index is trading more than 30% below its high reached in February 2021.
It’s a sharp contrast to what’s happening in the US Treasury market and elsewhere, where expectations of a more inflationary environment following Donald Trump’s inauguration have propelled yields higher. Inflation Divergence
China's inflation is hovering near zero while Japan's picks up
Source: Bloomberg
But Japanification — if it really happens — will also create opportunities for investors. In several reports published last year, Chinese brokerage Haitong Securities Co. looked at the winners of Japan’s lost decades, pointing to opportunities in investments including high-dividend stocks, technology companies with room to grow and exporters with diverse revenue streams.
Max Dong, a partner at Guangzhou JiuYuan Private Fund Management Co., said his firm has already made profits on dividend stocks, after doing its own research on Japan. He added that his fund has switched to chipmakers after the central bank’s September stimulus announcement, based on the belief that China could avoid going down the same path as Japan.
Some, like veteran emerging-market investor Mark Mobius, believe China has the tools to avoid following Japan’s fate. “Since the government has an outsized control over the economy, they have the ability to implement financial measures designed to reduce or even eliminate many of the negative elements,” he said.
Still, the clock is ticking for China, and analysts say Beijing needs to learn fast from its neighbor’s ailments. One common piece of advice is for authorities to revive animal spirits across the economy and incentivize people to spend — a tall order given the ongoing crisis of confidence.
Japan’s economy only started to respond positively once policymakers “finally began to directly transfer funds to the people’s pockets,” rather than plow money into infrastructure and companies, said Jesper Koll, an expert director at Monex Group Inc., who has been researching Japan for decades. It “took basically 20 years before politicians learned that lesson — I hope China’s leaders have learned this lesson and have the wisdom to boost the people’s purchasing power.”
