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After peaking at a five-year high of 7.0% in July, growth in China slowed to 6.2% in the twelve months to April, according to the latest reading from our China Momentum Indicator 2.0 (CMI 2.0). We see true economic growth in China continuing to weaken, averaging 5.7% in 2018. China’s economy has approached a threshold. International experience suggests that the accumulation of bank credit beyond 250% of GDP stops being effective and starts to damage growth. China passed that point towards the end of 2016. The route to boost aggregate demand cannot, or at least should not, be ever more investment. Fixed investment creates capacity: the flow of investment boosts aggregate demand in the year in which it is undertaken, but it boosts aggregate supply capacity for many years thereafter. In the end, the excess capacity that it generates creates its own problems: negative real returns on investment and non-performing loans in the banking sector. This is where China finds itself today. Investment only makes sense if there is some other source of aggregate demand that will ultimately mop up all that productive capacity. China needs to develop a source of final domestic demand — not investment but consumption — to absorb the growth in productive capacity to which it is already committed. However, China’s policymakers have not yet enacted the reforms which would be necessary to facilitate this shift.
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