China's Slow-Motion Shock: How Beijing's Deflation Battle Shapes the World

Officially, China looks...fine.

Real GDP grew 4.8% year-over-year in the third quarter of 2025, keeping Beijing on track for its "around 5%" GDP growth target. Inflation is barely positive. Unemployment is contained. On the surface, it's a soft-landing story.

Under the surface, it's something closer to a slow-motion economic crisis, with deflation in China, a property bust, and a stock market held up in part by state support. For U.S. investors, this matters in two ways:

1. China is exporting deflation and cheap goods to the rest of the world, reshaping global inflation, supply chains, and global trade politics.
2. Chinese equities are increasingly a policy trade, not a pure macro trade, and the parts of the market you choose (or avoid) will matter more than ever.

Let's unpack what's happening and then talk about what, if anything, might still be investable in China through U.S.-listed ETFs.

1. China's quiet deflation problem

Start with a simple but powerful discrepancy:

• Real GDP (adjusted for inflation) grew 4.8% in Q3 2025.
• Nominal GDP (in current prices) grew only 3.7%.

When real growth is higher than nominal growth, it means the average price level across the economy is falling. That's captured by the GDP deflator, which has now been negative for 10 straight quarters – the longest such stretch in decades.

At the consumer level the picture looks deceptively benign:

• CPI was up just 0.2% year-over-year in October, ending a brief dip into outright consumer-price deflation.
• Producer price index (PPI) fell 2.1% in the same month, keeping factory-gate prices deeply in the red.

A Bloomberg analysis of dozens of everyday goods found that prices fell for 51 out of 67 tracked items, from groceries to household products, a drop far sharper than the headline CPI suggests.

The deflationary spiral

Economists worry less about one-off price drops and more about deflationary dynamics – feedback loops that are hard to break. In China today, that loop looks roughly like this:

1. Shock to wealth and income
   • Property values in major cities have fallen roughly 25–30% from their recent peaks, wiping out a huge chunk of household balance-sheet wealth.
   • Wage inflation in the private sector has slowed, especially for younger workers, contributing to youth unemployment concerns.
2. Households go into "lockdown mode" on spendingChinese households have responded by hoarding cash. Savings now amount to roughly 110–120% of GDP, an unprecedented level for a major economy. Consumption, meanwhile, accounts for only ~40% of GDP – far below the U.S., where household consumption is closer to 68%. This reflects a decline in consumer confidence and increased precautionary savings.
3. Businesses respond with price warsWith demand weak and excess capacity high, companies cut prices aggressively just to keep factories running. Chinese officials and media have popularized the term "neijuan", often translated as "involution" – a destructive race to the bottom in which firms work harder for shrinking profits.
4. Margins collapse, investment stalls, layoffs riseAs profit margins compress, companies cut capex and jobs. That reinforces consumer anxiety and keeps spending depressed, further impacting the cost of living.
5. Consumers delay spending even moreIf you expect prices to be lower in six months, you put off big-ticket purchases. That's the essence of a deflationary spiral.

The upshot: China is still growing in volume, but the value of that output is being eroded by falling prices. That's a very different challenge than the inflation concerns the U.S. has grappled with since 2021.

2. Property bust + "zombie" companies = balance-sheet recession

The single biggest shock behind this deflation: China's real estate slump.

• Home prices in major cities are down roughly 27% from their recent highs, according to Bloomberg estimates, with new-home prices in many cities still falling.
• Developers like Country Garden and Vanke have faced massive losses, restructurings, or market panic.

Property has long been the "national piggy bank" – a store of wealth for households and a key source of collateral for companies and local governments. When that asset deflates, everyone tries to repair their balance sheet at once.

The rise of "zombie" firms

The damage doesn't stop at property developers. A large swath of corporate China is struggling:

• Over 25% of listed Chinese companies reported losses in the first half of 2025, the highest share in at least 25 years.
• Research based on Bloomberg data suggests roughly one-third of listed firms are now "zombies" – their operating profits don't even cover interest payments on their debt.

These firms are kept alive by cheap credit, state support, or soft-budget constraints. They rarely invest aggressively, they drag down productivity, and they absorb capital and labor that could be used by healthier companies.

Why rate cuts don't fix this

This is classic balance-sheet recession territory:

• When asset values plunge and debt remains, households and companies focus on paying down old loans, not taking out new ones – even if rates fall.
• The People's Bank of China has nudged rates lower and cut banks' reserve ratios, but credit demand remains lukewarm.

From an investor's perspective, that means:

• Macro stimulus has less punch than in past cycles.
• The gap between weak "old economy" sectors (property, heavy industry, many SOEs) and favored "new economy" sectors (tech, green energy, advanced manufacturing, digital services) is widening.

3. Exporting deflation: China's record trade surplus

If domestic consumers won't absorb China's output, someone else has to. That "someone else" is the rest of the world.

China's goods trade surplus hit a record $586 billion in the first half of 2025, up 34% year over year, and analysts expect the full-year surplus to approach or exceed $1.2 trillion – an unprecedented number for any major economy.

Bloomberg and other analysts note that China is effectively "flooding the world with cheap exports": everything from basic apparel to solar panels, batteries, and electric vehicles (EVs).

This "export of deflation" has two big channels:

1. High-tech industriesChina has poured capital and subsidies into "strategic" sectors: EVs, batteries, solar, artificial intelligence hardware, advanced manufacturing. That creates enormous exportable capacity, which is now hitting global markets at aggressive prices – and hitting competitors, especially in Europe and parts of Asia.
2. Low-tech, low-margin goodsAt the same time, China remains a powerhouse for cheap consumer goods: $2 T-shirts, $12 jackets, low-end electronics and home products. This puts pressure on manufacturers in countries like Indonesia, Vietnam, and Bangladesh that compete in low-cost niches.

For the U.S., the story is mixed:

• On the one hand, cheap Chinese goods help keep U.S. goods inflation in check, supporting the Fed's disinflation process.
• On the other, they intensify political pressure for tariffs and industrial policy, adding uncertainty for global supply chains and U.S. multinationals.

4. The U.S.–China "tactical truce": calm, not peace

2025 has seen a trade war, then a partial truce.

• U.S. tariffs on Chinese imports were pushed to very high levels earlier in the year, then partially rolled back under a series of temporary agreements.
• In late 2025, Washington agreed to halve certain fentanyl-related tariffs and pause some new export-control rules in exchange for Beijing's pledge to curb the flow of precursor chemicals, resume large purchases of U.S. soybeans and other goods, and delay new rare-earth export restrictions.
• The two sides have repeatedly extended short-term tariff truces by 60–90 days at a time, keeping markets on edge.

Analysts across the political spectrum describe this as a tactical ceasefire, not a structural reset.

For investors, the implications are:

• Tariff and export-control risk is now a recurring feature, not a one-off shock.
• Policy can flip from "de-escalation" to "re-escalation" on a short news cycle, especially around elections or geopolitical flashpoints.
• Sectors tied to semiconductors, artificial intelligence, and dual-use technologies remain particularly exposed.

5. Beijing's cautious stimulus – and its paradox

With economic growth slowing and deflationary pressure persistent, many economists have urged China to do what the U.S. did in 2020–21: large-scale fiscal transfers to households ("helicopter money"). Beijing has resisted.

Instead, China's policy response has three main pillars:

1. Moderately loose monetary policyThe PBOC has cut reserve requirements and some policy rates, and it has rolled out targeted lending tools for sectors like services, green development, and tech innovation.
2. Targeted fiscal stimulusPolicy banks are channeling around 500 billion yuan (~$70 billion) in low-cost loans into eight priority sectors, including AI, green industry, and infrastructure, with the aim of leveraging trillions of yuan in total investment.
3. Direct support for the stock market
   • A 500-billion-yuan swap facility allows brokers and funds to borrow against stock and ETF holdings.
   • Regulators have leaned on insurers and mutual funds to increase equity allocations, a move that could channel roughly another 500 billion yuan into local stocks over time.

Here's the paradox:

China's core problem is weak domestic demand. Yet much of the stimulus is supply-side, funding more factories for EVs, solar panels, data centers, and AI chips. That:

• Boosts capacity and keeps growth near the 5% target in the short term, but
• Worsens overcapacity and intensifies the need to export even more, reinforcing deflationary pressure at home and trade tensions abroad.

6. Markets vs. macro: the rise of the "Beijing Put"

Given this macro backdrop, you might expect Chinese equities to be in freefall. Instead:

• The Shanghai Composite has climbed above 4,000 for the first time since 2015, hitting decade-high levels in late October and early November.
• The MSCI China Index has rallied about 33% since early-year lows, helped by an AI-driven surge in tech stocks.
• JPMorgan and several global houses have upgraded China to "overweight", citing AI adoption, targeted stimulus, and corporate governance reforms.

This divergence between a shaky macro picture and a buoyant equity market has given rise to the phrase "Beijing Put" – the idea that Chinese authorities will step in to limit downside in A-shares and key indices. Asset managers have started using this term explicitly to describe the current policy regime.

What's actually driving the market?

• Liquidity and policy support, not a broad-based earnings boom. Corporate profits, in aggregate, have grown only modestly and remain fragile in many old-economy sectors.
• Rotation into favored sectors (tech, internet, green energy, industrial automation) – the parts of the market most aligned with Beijing's long-term plans.

For investors, the takeaway is that China's equity market has become even more policy-sensitive than usual. You're not just betting on earnings; you're also betting on what Beijing wants to support.

7. What this means for U.S. investors

Big-picture implications

Even if you never own a single Chinese stock or ETF, China's current trajectory affects you:

• Global inflation and interest ratesChina's deflation and export surge help cap goods inflation globally, which can ease pressure on the Fed, but also reflects weaker global demand.
• Trade and industrial policy riskIndustries ranging from autos to solar to semiconductors are being reshaped by China-centric supply and price shocks, and by Western responses in the form of tariffs, subsidies, and reshoring.
• **Emerging markets exposure**Many EM countries are deeply tied to Chinese demand (commodities) or competition (manufacturing). Indonesia's recent export slowdown, for example, reflects weaker Chinese demand for coal and copper.

If you own broad EM equity or debt funds, you are already exposed to China, directly or indirectly.

If you do want China exposure: what to avoid

Given the macro picture, many analysts argue that investors should underweight or avoid:

• Highly levered property developers
• Banks heavily exposed to the property sector and local government debt
• Capital-intensive, state-dominated heavy industry
• Broad "all-China" funds that carry large weightings in state-owned enterprises (SOEs) and old-economy sectors

A commonly cited example:

• iShares MSCI China ETF (MCHI) – a broad China ETF – allocates roughly 28% to consumer discretionary, ~23% to communication services, and ~18% to financials, including big state-run banks.
  • If your goal is to play China's "new economy" and policy-favored sectors, that kind of financials/old-economy exposure can be a bug, not a feature.

Where selective exposure can still make sense: 3 ETFs to know

Important: What follows is not personalized investment advice. It's a framework for thinking about China exposure; your own allocation should reflect your risk tolerance, horizon, and overall portfolio.

1. KraneShares CSI China Internet ETF (KWEB)

• What it owns: Chinese internet and internet-adjacent firms – think of it as a basket roughly analogous to owning a mix of U.S. mega-cap platforms and e-commerce names.
• Sector profile: Roughly 43% communication services and 38% consumer cyclical, with smaller weights in health care and other sectors.
• Top holdings: Tencent, Alibaba, Meituan, JD.com, PDD, and other large platforms.

Macro fit:

• This is essentially a leveraged bet on Chinese digital consumption and advertising, plus the monetization of AI and cloud services.
• It’s indirectly supported by policy to the extent that Beijing wants robust domestic platforms and digital infrastructure, but also exposed to regulatory risk (antitrust, data, content controls).

Who it may appeal to:

• Investors who believe China’s internet giants will keep compounding as the economy rebalances toward services and the middle class, and who can tolerate high volatility and political risk.

2. Invesco China Technology ETF (CQQQ)

• What it owns: A broader slice of China’s tech ecosystem: hardware, software, internet, e-commerce. It tracks a tech-heavy FTSE China index.
• Sector profile: As of late 2025, about 48% technology, 32% communication services, and 18% consumer cyclical.

Compared with KWEB, CQQQ:

• Includes more hardware and semiconductor names, giving you exposure to China’s push for AI chips and tech self-reliance, not just consumer platforms.
• Still tilts heavily toward the policy-favored parts of the economy and away from property and traditional heavy industry.

Who it may appeal to:

• Investors who want a broader “new-economy” China tilt – AI, chips, platforms, digital services – while still betting that Beijing will back these sectors as part of its long-term industrial strategy.

3. MCHI – a benchmark to measure against, not necessarily a buy

As noted above, iShares MSCI China ETF (MCHI) gives you broad exposure to large and mid-cap Chinese equities.

• Pros:
  • Better diversification across sectors.
  • More “market-like” China exposure if you don’t want to make sector calls.
• Cons in today’s context:
  • Significant weight in banks and other financials that are tied to the property and local-government debt overhang.
  • Meaningful exposure to SOEs whose priorities may be more political than shareholder-driven.

In other words, MCHI is useful as a baseline, something to compare more targeted funds against, but it may not be the cleanest way to express a view on the “Beijing Put” or on China’s digital/tech sectors specifically.

This ETF selection was recommended using insights from 8FIGURES AI Investment Advisor. If you want similarly smart, data-driven investment ideas tailored to your goals, you can get them anytime with 8FIGURES AI.

8. How to think about China in a U.S. portfolio

Putting it all together:

1. China is not just in a cyclical downturn; it’s undergoing a structural shift
   • From property- and investment-driven growth toward exports and selective high-tech manufacturing.
   • With deflationary undertones and a household sector still in repair mode.
2. Policy matters more than ever
   • The stock market is buoyed by the “Beijing Put”, liquidity tools, and regulatory pressure on institutions to buy stocks.
   • But those same policymakers are unwilling, so far, to deliver the kind of household-focused stimulus that would end the balance-sheet recession.
3. China is exporting its problems – as well as its opportunities
   • Deflation and overcapacity are pushed abroad via record exports and a massive trade surplus, intensifying trade frictions, especially in autos, green tech, and intermediate goods.
4. For investors, broad “buy China” calls are less compelling than targeted ones
   • Avoid or underweight: property, overlevered financials, heavy SOEs.
   • Consider, in measured size: vehicles like KWEB or CQQQ that align with Beijing’s push into digital services, AI, and advanced manufacturing, recognizing that these are high-volatility, high-policy-risk trades, not core holdings.
5. Size and diversification matter
   • Given geopolitics, regulatory uncertainty, and data opacity, many U.S. investors treat China as a small tactical satellite, not a core equity allocation.
   • Diversifying China exposure via broader EM or Asia ex-Japan funds, rather than a big single-country bet, remains a reasonable default for more conservative investors.

Final thought

China’s economy is in a strange place: headline growth that looks respectable, underpinned by deep deflationary and structural stresses, and a stock market that’s being propped up in part by policy design.

For U.S. investors, that doesn’t mean “never touch China”, but it does mean knowing exactly which China you’re buying:

• The overbuilt, debt-laden old economy trying to survive, or
• The policy-favored, tech-heavy new economy that Beijing is determined to scale – even if it has to export its deflation along the way.

Whichever path you choose, it should be a conscious, sized-appropriately risk in your portfolio – not an accidental byproduct of owning a broad index.

REFERENCES:

1. Bloomberg News. “Chinese Manufacturing Is Slumping Despite Boost From Exports", Bloomberg, 2025. https://www.bloomberg.com/news/articles/2025-12-01/china-factory-gauge-unexpectedly-dips-in-sign-of-deeper-slowdown
2. Bloomberg News. “The True Cost of China’s Falling Prices.” Bloomberg, 2025.https://www.bloomberg.com/graphics/2025-china-deflation-cost/
3. Divvydiary. “KWEB – KraneShares CSI China Internet ETF, Sector Breakdown.” 2025.https://divvydiary.com/en/kraneshares-csi-china-internet-etf-US5007673065
4. National Bureau of Statistics of China. “Consumer Prices in October 2025.” 2025.https://www.stats.gov.cn/english/PressRelease/202511/t20251110_1961831.html#:~:text=In October 2025%2C China's Consumer,by 0.2%25 year on year.
5. The Economist. “China’s property market is (somehow) worsening” The Economist, 2025.https://www.economist.com/finance-and-economics/2025/11/27/chinas-property-market-is-somehow-worsening