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U.S. President Joe Biden and China's President Xi Jinping meet on the sidelines of the G20 Summit in Nusa Dua on the Indonesian resort island of Bali on Nov. 14, 2022.SAUL LOEB/AFP/Getty Images

China’s leaders are currently gathered for their annual summer retreat at Beidaihe, a resort on the Bohai Sea, some 250 kilometres east of Beijing. Exactly what is discussed at such meetings is kept highly secret, but one topic certain to come up this year is the increasingly dire state of the Chinese economy.

While much of the West continues to grapple with inflation, China this week revealed it was experiencing the opposite, as consumer prices tipped into deflationary territory for the first time in two years, adding more stress to an economy already dealing with widespread (and worsening) unemployment, sluggish exports and a housing downturn. Deflation can lower spending as consumers put off purchases, and companies respond by slowing production, potentially leading to layoffs.

On Wednesday, Washington added to those woes when President Joe Biden signed an executive order limiting U.S. high-tech investments in China. Most analysts see this as just a preview of far more aggressive U.S. policy to come, particularly if Republicans win control of the government next year.

Ottawa said it was in close contact with Washington in order to understand the new regulations and how they might affect Canadian businesses.

Beijing, meanwhile, denounced Mr. Biden’s order Thursday as “deviating from the principles of market economy and fair competition.”

Elaine Dezenski, a senior director at the Foundation for Defense of Democracies, said the move comes “at an inopportune moment for Beijing.”

Foreign investment in China is already at a 25-year low, the result of a pandemic-era pullback amid lockdowns and supply-chain disruptions, increasingly hostile policy-making from Beijing and concern among foreign companies about additional scrutiny and pressure back home for their ties to China.

Reacting to Mr. Biden’s executive order, Marco Rubio, a leading Republican China hawk, called it “laughable” and promised to introduce tougher legislation. He previously sponsored a bill that would block federal retirement plans from investing in Chinese companies.

Canadian pension funds are already reassessing their exposure to China, given the uncertainty surrounding the country’s economy and growing scrutiny of any ties to Beijing amid concerns about Chinese interference in Canadian politics.

“Investors have been really disappointed about the scope of the rebound and are pessimistic about the future,” said Nick Marro, the lead global trade analyst at the Economist Intelligence Unit. “But they’re also worried about geopolitics, and it’s those anxieties, not just over Taiwan or U.S.-China relations, but also around policy restrictions coming from home markets which can really complicate investment moving forward.”

Domestically, the picture is just as dire. Draconian COVID-19 restrictions created a severe drag on the economy, and a hoped-for recovery has been lacklustre and already looks to be petering out. This has combined with record-high youth unemployment – which hit 21.3 per cent in June and is likely to worsen as millions more graduates hit the job market next month – low exports and renewed concerns over a housing sector widely seen as a bubble.

Property sales are down about 20 per cent from last year, according to data from the National Bureau of Statistics. Home prices have fallen some 14 per cent from a peak in August, 2021, while rents are down 5 per cent in the same period, the New York Times reported, citing analysis from Beike Research Institute, a Tianjin firm.

Previous attempts by the government to gradually ease home prices almost caused the collapse of one of the country’s largest developers, Evergrande, and led to protests outside its offices. For many Chinese households, apartments are their main store of wealth, and a sharp drop in prices could spark widespread dissatisfaction and even unrest, while further suppressing consumer spending.

Beijing has long struggled to promote domestic demand, seen as vital to rebalancing the economy away from a dependence on exports. China’s consumer price index fell 0.3 per cent in July, after remaining static the previous month. The Producer Price Index, which tracks what businesses pay suppliers, is down 4.4 per cent.

“Consumption has always been the tricky part of the Chinese growth story, and over the pandemic consumption really collapsed, because how can you consume when you’re in lockdown?” said Mr. Marro. “The legacy of the pandemic has been long-lasting: You had shocks to income, shocks to employment, shocks to sentiment, which has been really, really hard to rebuild.”

Despite insistence from officials that the picture is not as gloomy as it seems, Mr. Marro said the feeling on the ground “is one of a lot of anxiety,” which is leading many to tighten their belts ever further.

Ms. Dezenski said increased private-sector aversion to investment “will only compound the dangerously high youth unemployment, deflation risks and sagging exports – creating a perfect storm of conditions for a Chinese economic collapse.”

Fears of such a spiral have renewed calls for a government stimulus, but so far policy-makers have been cautious. Even during the pandemic, China did not employ the type of direct cash transfers to boost spending widely used in the West and several Asian territories, including Hong Kong.

Last week, officials called on local and provincial governments to boost spending, but many regions are already in a precarious financial condition, and experimentation has become rare because Chinese President Xi Jinping has centralized power under himself, including a tight grip on economic policy.

“There’s a lot of concern around potential missteps,” Mr. Marro said. “There’s fear that if you do something which isn’t completely signed off by the very top of the government, that it could be a mistake and put you in jeopardy.”

He doubted that China would technically enter a recession – defined as two-quarters of negative GDP growth – given the many tools policy-makers have used in the past to boost the economy and juice official figures. But he warned that Chinese consumers may feel like they are in one regardless.

“That could hold back consumer spending even more. It could hold back business investment and further sour foreign investors on China,” Mr. Marro said. “And so even if we don’t see a classical recession, that doesn’t necessarily mean the Chinese economy is in a good state.”

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