China needs a stimulus bazooka, but it’s firing a scattergun

For Australian investors, it is worth noting that iron ore futures in Singapore experienced a 0.8 percent increase, reaching $US107.5 per tonne. The cost of this essential material used in the production of steel had surged to $US115 last week after the Chinese Politburo (President Xi Jinping's cabinet) declared plans to boost the economy. However, this price hike has quickly diminished.

According to Citi analyst Wenyu Yao, there are two factors influencing the situation. Firstly, the measures taken to stimulate the economy did not meet the anticipated results. Additionally, China seems to be restricting the production of certain steel manufacturers. Citi predicts that due to an excess of supply compared to demand in the second half of the year, the price of iron ore will drop to $US100 per tonne.

The iron ore demand in China heavily relies on the property industry, which makes up around 35 to 40 percent of steel usage. However, according to Barclays strategist Kaanhari Singh, the property sector is also crucial to China's efforts in stimulating the economy because it represents 60 percent of the overall assets owned by Chinese households.

She explains that the challenge of the stimulus is twofold. While the government can assist financially troubled developers who are facing difficulties in obtaining funding and completing their projects, "a genuine improvement in public attitude towards households relies on property values beginning to show positive changes." However, achieving this is challenging due to the oversupply in the real estate sector and the already high rate of home ownership.

Singh states that around 21 percent of household assets are comprised of financial assets, predominantly wealth management products and stocks. Therefore, an increase in positive sentiment within the stock market is favorable. However, if this does not result in improved company earnings, the rise in sentiment may only be short-lived.

There are also two significant issues that are prominently present in the Chinese economy.

One concern is the large amount of debt, which could become an even bigger issue if deflation becomes firmly established.

According to Albert Edwards, a strategist at Societe Generale, the recent drop of China's GDP deflator by 1.5 percent in the second quarter indicates a widespread deflationary crisis in the economy. This decline in prices, which hasn't been seen since the Global Financial Crisis, suggests that deflation is exerting significant pressure on all sectors of the economy.

"And we certainly understand that deflation can be disastrous for heavily indebted economies – which is the current situation in China," he remarks.

The next obstacle lies in the area of demographics. In addition to the fact that the population is growing older, there is an alarming rate of unemployment among the younger generation, as the official statistics indicate a staggering 21.3 per cent.

And it is possible that the number is even greater than this, according to the assessments made by Peking University professor Zhang Dandan. Professor Zhang mentions that the figures provided do not include 16 million students who are not actively looking for employment. Even if we consider the official figures, it is clear that the stimulus package announced thus far would be insufficient to address the issue of unemployment among young workers and stimulate their spending.

Perhaps China's powerful weapon will eventually emerge. However, Singh from Barclays argues that despite China's apparent satisfaction with maintaining a 5% GDP growth target, complex macroeconomic issues remain unresolved.