Xi Jinping is deliberately running China’s economy cold.

Xi Jinping’s quest to rewrite a playbook that has driven China’s economic miracle over a decade is facing its toughest test yet.

$18 trillion is slowing down. Consumers are depressed, exports are in trouble, prices are dropping, and one fifth of young people have no job. Country Garden Holdings Co. is at the brink of default, and protestors are gathering in Zhongzhi Enterprise Group Co. one of the largest shadow banking to demand their money, as payments have been halted.

President Xi has been determined to move away from the debt fueled growth model that his predecessors used. As the real estate crisis worsens, the measures taken to mitigate the impact are limited. Forecasters like JPMorgan Chase & Co. Barclays Plc, and Morgan Stanley have downgraded their estimates for China’s growth in this year below the government’s 5% goal.

The central bank is stepping up efforts to stop the yuan from falling towards the lowest level in 2007 and pulling out foreign investors. Treasury Secretary Janet Yellen called China a risk factor for the US this month, while President Joe Biden referred to China’s economy as a ticking time bomb at a recent political event.

It is possible that the clash in economic philosophy between the two world’s largest economies will delay or even prevent from ever happening. The biggest risk facing Xi, his team and Premier Li Qiang, Vice Premier He Lifeng is that their determination to avoid excessive stimuli will undermine the confidence of the nation’s 1.4billion people.

Bert Hofman said that China is experiencing an “expectations” recession. Bert Hofman was the former China Country Director at the World Bank. “Once everyone believes that the growth rate will slow down in the future, it will self-fulfill.”

In the worst case scenario, this dynamic results in stagnation or “Japanification”, something that some economists perceive as a warning in China’s recent consumer price data which shows deflation. Prices falling are a sign of a weakening demand and can also be a drag on growth in the future as consumers delay purchases and business profits drop.

A China slump, if global markets are spooked by it, could cause investors to flee riskier assets all over the world. This is what happened in 2015 when a devaluation of the Chinese currency and a stock market meltdown in the United States alarmed Yellen at the time, who was then chair of the Federal Reserve, enough to cancel an interest rate hike. A repeat performance may see the Fed’s expectations upended, as a pause could turn into a rate cut sooner than expected.

The nominal GDP (which does not adjust for inflation) is a good indicator of the differences in economic approaches between China and the US. The nominal growth rate in the US is 6.5% this year, compared to 4.8% in China. However, China’s economy continues to grow faster than America’s. China’s rival has also benefited from the strengthening of the US dollar against the Chinese yuan, at least for the moment, when measured by GDP in dollars.

Xi, and the Communist Party leadership, haven’t sat back. Following a Politburo Meeting last month, a series of announcements were made, including proposals for faster infrastructure spending, more liquidity support for developers, and lowered housing purchase restrictions. Last week, the interest rate was cut unexpectedly.

To understand why Beijing hasn’t done much more, you need to look at the state of the economy from Beijing’s point of view — and Xi himself’s views on how to best achieve the overarching goal to turn China into a country that “leads in the world when it comes to composite national strength and global influence by the mid-century.”

Electric vehicles, wind and solar power, and batteries are all booming sectors of the economy. Investment and exports in these areas are increasing at double-digit growth rates. This is exactly the type of hi-tech green growth Xi desires. Even though the government is imposing austerity on some areas, it is committing resources to encourage this type of growth. It is issuing bonds for high-speed rail infrastructure and renewable energy infrastructure at a scale that is unmatched in the world. It is also providing cheap loans to businesses and generously supporting consumer demand by offering tax breaks to EV buyers.

In the meantime, spending on travel and restaurants is up significantly compared to last year’s lockdown. Starbucks reported a 46% increase in sales for the last quarter of China. Domestic flights are about 15% higher than they were before the pandemic. And travelers complain that budget hotels have raised prices because of soaring demand. This creates many jobs and helps ease the fear of mass unemployment among the Chinese leadership.

The real estate crash is still a huge drag on the economy.

Beijing estimates that the “new economy,” which includes green manufacturing and other high-tech sectors like microchips, grew by 6.5% year-on-year in the second half of the year. This accounted for slightly more than 17% GDP. Real estate construction expenditures, on the other hand, fell by almost 8% during the first half of the year. The property sector accounts for about 20% GDP when you include related industries.

In late 2020, the real estate market was reshaped when authorities announced ” Three Red Lines”, which outlined leverage benchmarks builders needed to meet in order to borrow more. China Evergrande Group defaulted by the end of 2021. This was followed by a surge in other builders’ debt failures. Country Garden, once China’s largest developer in terms of sales, has warned that it faces ” significant uncertainties”.

Real estate sales are down by 50% from their peak in 2020. This is not only affecting the property industry and its related industries, such as construction, steel, concrete, and glass. This contraction has also affected household confidence. In all likelihood, home values are falling and much more that the modest single-digit figures reported by official data. Citigroup Inc. estimates that real estate represents up to 70% of China’s wealth and 40% of the collateral held by banks.

In a second blow against growth, the loss of wealth makes households feel poorer and reduces their appetite for consumption. As companies reduce their profit expectations and cut back on investment and hiring, the effects multiply. Cities have warned about the oversupply of private taxi drivers in the gig economy, a sign of low labor demand.

Some call on Beijing to take strong measures to build confidence and break the cycle. Cai Fang, a central bank adviser, recently called for direct stimulus to consumers. He and other economists agree that a few trillion dollars (hundreds billions of yuan) in central government borrowings would boost consumption.

Beijing will not accept these proposals. Wang Tao is the chief China economist at UBS Group AG. He said that for China’s leaders, “the best way of supporting consumption is by supporting employment. This is best done through supporting corporate sector” via tax cuts.

The central government is still committed to a fiscal target of 3% GDP. Xi has previously warned against “welfarism,” a trap that senior officials claim can lead to laziness. There are also political issues in deciding what households get in a country with 1.4 billion people and a vastly unequal population.

Xi, while not abandoning the long-standing interest of the party in top-line growth, has added a number of new objectives that officials should work toward. He has repeatedly reminded party members and bureaucrats to not sacrifice national security, risk mitigation and pollution reduction for higher growth. He’s had a hard time making this distinction.

“Most cadres are able to adapt actively to the new requirements for development, but some cannot keep up,” Xi stated in remarks made earlier this summer. Some people think development is all about starting projects, making investments and increasing scale.

Michael Hirson is a former US Treasury Attaché in Beijing. He notes that “Xi stressed at key points this past year that local officials must stay disciplined and avoid financial risks, but “now, they are being told to also support growth.” Most officials will therefore see modest stimulus efforts as the safest course of action.

Many observers conclude that China will get by with limited stimulus measures and targeted assistance for businesses, rather than a full-blown stimulus plan. Bold moves are not out of the question, especially if political risks become too high. After all, Xi was forced to dismantle the Covid-era restrictions on mobility late last year after spontaneous protests including calls for his removal. Until now, raising expectations was pushed to the back burner by concerns about a possible housing bubble and wasting state funds that could trigger a bigger crisis in the future. Now, the big question is how much economic decline Xi and top aides will tolerate.

Zhu Ning is a professor of the Shanghai Advanced Institute of Finance and has advised China’s Government. He says that he has noticed a recent shift in the tone towards the property sector, and he expects to see more concrete support.

Zhu stated that the bottom line was whether or not they were willing to increase their fiscal deficit. “At this moment, policymakers remain hesitant. But maybe economic realities will change their mind.”