Economist Li Xunlei Warns of a Stock Market Fever Hiding an Economic Chill
He Urges a Halt to Deleveraging, a Shift from Inefficient Infrastructure to Next-Gen Tech, and Boosting Household Income
On many occasions, Chinese intellectuals talk about foreign countries when they really mean China, or discuss history when they're actually commenting on today. It makes for clever, enjoyable wordplay among insiders, but it can really confuse outsiders who don't get the cultural context. Li Xunlei's latest piece on Japan is a perfect example. He seems to be dissecting Japan's policy hits and misses during their "lost thirty years," but he's really offering advice for China's economy, and I believe some of my readers need some sort of “translation.“
Li Xunlei serves as Chief Economist at Zhongtai Securities, bringing over three decades of experience in macroeconomic, financial, and capital market research. As one of the pioneers in China's securities market analysis, he remains influential in policy circles—most recently joining Premier Li Qiang's April 9 symposium on economic conditions alongside other leading experts and business leaders.
In the article, he argues that pumping tons of public money into infrastructure in areas where people are leaving just creates massive government debt with terrible returns on investment. His point: China shouldn't throw money at projects with diminishing returns just to prop up short-term growth numbers, especially when these projects go against where people actually want to live and work.
Looking at Japan's industries, he notes that when their traditional sectors declined, Japan didn't go all-in on building new globally competitive industries. The result was a hollowed-out economy with no new growth drivers. This leads him to push for proactive industrial policy—he wants the government to commit serious resources to upgrading manufacturing and developing cutting-edge industries to stay competitive globally. (more exciting stuff for capital to invest)
On consumer spending, he points out that Japan focused way too much on production investments and not enough on getting people to spend. So for China, success should be measured by whether regular people are earning more and feeling confident enough to spend. Bottom line: America's approach (put money in people's pockets) beats Japan's approach (build more stuff).
When it comes to actually implementing policies, he thinks Japan's biggest screw-up was its inconsistent and uncoordinated macroeconomic policies. Their central bank was slow to react, they kept flip-flopping between spending sprees and austerity measures, and revolving-door prime ministers meant no consistent strategy. China needs to avoid panic-switching to austerity just because of some bad monthly data or debt worries—that would kill any recovery momentum.
On the high debt that comes with big spending, his take is that it's totally normal for governments to borrow more when businesses and households are paying down debt—forcing everyone to deleverage at once would be a disaster. The real question isn't about cutting debt ratios right now, but about spending public money wisely—getting better bang for the buck, building a stronger economy that can eventually handle the debt burden. (good to see that last September’s politburo meeting has adopted that kind of thinking)
The article was first published on his WeChat account. (another example why WeChat is essential) But for those who don’t, here’s the ver on web:
https://finance.sina.cn/zl/2025-09-02/zl-infpatcf6903070.d.html?vt=4&cid=79615&node_id=79615
Below is the translated version of the article:
Why Do We Feel "Hot" When Hypothermic?
I’ve come across many reports about hypothermia. One that left a deep impression on me is the story of Lincoln Hall, an Australian mountaineer. In 2006, on his descent after summiting Mount Everest, he suddenly fell ill. His companions mistakenly thought he had died and left him on the mountainside at over 8,000 meters above sea level. Yet he survived the night in temperatures below -30°C and with limited oxygen. When he was found, he was actually trying to take off his jacket.
Another widely reported case of hypothermia occurred in 2021 during an ultramarathon in the Yellow River Stone Forest region of Baiyin, Gansu Province, where extreme weather led to hypothermia and the tragic death of 21 participants.
Hypothermia generally occurs when the body loses heat faster than it can produce it, causing the core body temperature to drop below 35°C. This leads to symptoms such as shivering, confusion, heart and respiratory failure, and can even be fatal.
Swedish medical researchers analyzed 207 fatal hypothermia cases and found that 63 of them involved “paradoxical undressing.” What explains this phenomenon?
It turns out that when core body temperature drops too low, the brain’s ability to sense and regulate temperature becomes impaired. Blood vessels near the skin surface dilate abnormally, causing a surge of blood to the body’s surface and creating a false sensation of warmth. At the same time, impaired nerve signal transmission confuses the person into thinking they are overheating.
I’m certainly no medical expert—but it makes me wonder: when the economy grows “hypothermic,” could the market also experience this same false feeling of warmth? How much damage can such misleading signals cause to the economy?
Why is there such a significant gap between perceived temperature and actual temperature? Similarly, there is often a noticeable discrepancy between economic data and how the economy "feels." Much of the economic data is lagging because it is a statistical record of events that have already occurred. Our limited perspective when observing the macroeconomy inevitably leads to a situation akin to the parable of the blind men and the elephant; meanwhile, humans are emotional beings who tend to assign greater weight to recent data, often resulting in misjudgment.
The first case that comes to my mind is Japan's lost three decades. Since the collapse of its real estate bubble in the 1990s, the Japanese economy has been mired in long-term deflation. For instance, in 1991, when the real estate market peaked, Japan's CPI stood at 93.1. It wasn't until the end of 2021 that it reached 100.1. Over 30 years, the cumulative increase was only 7.5%, averaging an annual rise of just 0.25%. Although Japan's CPI saw brief upticks during the East Asian financial crisis and the U.S. subprime mortgage crisis, it hovered around zero for the 30 years following the bubble's burst.
If we compare Japan's deflation to hypothermia, then the Japanese economy has been in a state of hypothermia for 30 years—the so-called "lost three decades." In terms of USD-denominated per capita GDP, it was $28,666 in 1991 (calculated at the average exchange rate for that year, same below). By 1994, Japan's per capita GDP had rapidly climbed to $38,467. This significant increase three years after the real estate bubble burst was due to the sharp appreciation of the yen, which soared from 145 yen per USD in 1990 to 94 yen per USD in 1995. In 1994, Japan's per capita GDP ranked highest in the world, even though the country was already experiencing rising non-performing loan ratios at banks, bankruptcies of certain banks and securities firms, sharp declines in corporate profits, and a severely weakened economy.
Thirty years later, in 2024, Japan's per capita GDP is only $32,420. When adjusted for inflation using 1994 constant prices, it is approximately $25,824—a 33% decrease compared to 30 years ago. In contrast, the U.S. per capita GDP was $28,000 in 1994. Calculated in 1994 constant prices, the 2024 U.S. per capita GDP reaches $57,000, more than double the 1994 figure. Therefore, judging by the trend in per capita GDP, Japan has not only lost 30 years but may have even regressed several years compared to three decades ago.
The stock market is a barometer of the economy. At the end of 1989, the Nikkei 225 index reached 38,900 points. After that, it plummeted significantly. Although there were multiple rebounds along the way, by July 2012, it was still only around 8,700 points—a mere fraction of its 1989 value.
Clearly, the Japanese economy did undergo a prolonged period of hypothermia. But what seems puzzling is why, during such an extended period of hypothermia, effective measures weren't taken to restore the economy to a "normal temperature"? This is related to a series of "misjudgments" by the Japanese government regarding the economy at that time.
For example, Japanese authorities were overly optimistic in estimating the impact of the real estate bubble collapse on the economy. The *Economic White Papers* released by the Japanese Economic Planning Agency in 1991 and 1992 both asserted that the negative impact of the burst bubble on personal consumption and corporate investment was very limited and would disappear after 1993. Simultaneously, the authorities did not pay sufficient attention to the risks that financial institutions would face. The 1990s saw a wave of bank failures, including notable ones like Daiwa Bank, Hokkaido Takushoku Bank, and the Long-Term Credit Bank of Japan. Additionally, major securities firm Yamaichi Securities collapsed, which was linked to the widespread bankruptcy of Japanese companies.
In terms of macroeconomic policy, monetary policy did not promptly shift from tightening to easing. The Bank of Japan (BOJ) was hesitant to cut interest rates. Starting in August 1990, the BOJ maintained the official discount rate at 6%. It wasn't until July 1991, 18 months after the stock market began falling, that the BOJ finally started cutting rates, and it was only by September 1995 that the rate was reduced to 0.5%. The BOJ's slow rate cuts were one reason Japan couldn't quickly escape deflation.
On the fiscal policy front, the Japanese government vacillated between expanding expenditures and fiscal consolidation (tax increases), leading to poor coordination between fiscal and monetary policies. For instance, in 1997, the consumption tax rate was raised from 3% to 5%, certain tax cuts were terminated, and the proportion of medical expenses borne by individuals was increased. The inconsistency in macroeconomic policy direction was also related to the frequent changes in prime ministers and the lack of policy continuity. From 1991 to 1998, Japan had seven different prime ministers, each with different approaches to solving the problem.
It's not difficult to see that Japan's fiscal policy at the time lacked targeted focus, with actual fiscal expenditures being relatively low in the early stages and efficiency being poor. For example, during the fiscal expansion phase, the government was fixated on productive investment and channeled substantial public funds into infrastructure projects in remote areas. This failed to stimulate private consumption and investment and did not generate a significant multiplier effect.
As can be seen from the chart above, Japan's public works expenditures increased significantly from 1992 to 1996. However, in terms of infrastructure investment, the funds were primarily directed toward roads, bridges, tunnels, large dams, and mountain and water management projects in regions with clearly declining populations, resulting in low investment efficiency. Numerous luxurious civic centers, museums, and stadiums were also constructed on a large scale, leading to a substantial rise in government debt. Moreover, many of these facilities were heavily underutilized, while young people continued to migrate to major metropolitan areas like Tokyo.
Why did such inefficient investment occur? First, it was driven by political interests, as the long-ruling Liberal Democratic Party relied heavily on votes from remote regions. Second, there was a traditional belief in balanced regional development, assuming that building roads would narrow the wealth gap. The Hashimoto administration, formed in early 1996, proposed the "Six Major Reform Principles" to address the lingering issues of huge fiscal deficits and public debt, which essentially entailed implementing fiscal contraction policies.
What lessons can be drawn from long-term economic "hypothermia"? In 2002, an American scholar named Alex Kerr wrote a book titled *Dogs and Demons*. The seemingly peculiar title actually alludes to a well-known Chinese parable: "Drawing ghosts is easiest." Kerr used this metaphor to highlight Japan's predicament—while effective solutions to existing problems were elusive, spending vast sums on showcase projects was effortless. From 1995 to 2007, Japan's infrastructure budget reached as high as 65 trillion yen, exceeding that of the United States during the same period by three to five times. Wu Jinglian also endorsed the Chinese version of this book when it was published.
I often say that uphill paths have downhill sections, and downhill paths have uphill sections, but neither changes the overall trend. In financial markets, there is a definition of a technical bull market: a rise of over 20% from a significant low. However, a technical bull market does not signify a fundamental improvement in the economy. So, does a rise of over 50% qualify as a bull market that serves as an economic barometer? During Japan's prolonged stock market decline, there were three notable "bull markets" with substantial gains.
The first occurred in June 1995, when the Bank of Japan injected approximately 2 trillion yen (a stabilization fund) to rescue the market. In September, the BOJ cut the policy rate from 1% to 0.5%, marking the beginning of Japan's zero-interest-rate era and the implementation of highly accommodative monetary policy. From June 1995 to June 1996, the Nikkei index rose by 55%. The second bull market happened in 1998 during the Asian financial crisis, when the yen depreciated sharply, and banks were on the brink of collapse. Japan injected capital into banks, the BOJ aggressively bought yen, and the government allocated 30 trillion yen for public investment. From September 1998 to March 2000, the index rose by 52%. The third bull market occurred from April 2003 to July 2007, when the index surged from around 7,800 points to 16,800 points, a gain of 132%. This was likely driven by the global economic upturn fueled by the prosperity of emerging economies. During this period, U.S. stocks also experienced a major bull market, while China's A-share market saw even larger gains, with the Shanghai Composite Index soaring from around 1,000 points to over 6,000 points.
However, it is worth pondering why Japan's stock market eventually fell back to historical lows. The reason is that after the real estate bubble burst in 1991, Japan failed to cultivate new industries with global influence. Whether it was e-commerce after the rise of the internet, the smartphone industry, new energy, electric vehicles, drones, next-generation robotics, or today's fiercely competitive artificial intelligence, Japan did not fully commit to participating. Without the rise of emerging industries, traditional industries inevitably become sunset industries. Lacking exciting profit-growth sectors or companies, the stock market naturally loses confidence and expectations.
From the perspective of Japan's credit allocation, investment in manufacturing has continued to decline, while real estate has maintained an upward trend. This reflects the issue of industrial hollowing-out in manufacturing. The proportion of manufacturing in total credit balances dropped from 35% in 1977 to 11% in 2021. In contrast, the proportion of real estate loans increased from 12.4% after the real estate bubble burst in 1993 to 16.7% in 2021.
Why has the proportion of manufacturing loans in Japan continued to decline? This is likely related to the sharp appreciation of the yen in the early 1990s and China's reform and opening-up. Currency appreciation favors overseas expansion, while depreciation benefits exports. In the first half of the 1990s, the yen appreciated significantly, while the renminbi depreciated sharply. Japanese companies heavily invested overseas, particularly in China. The influx of global capital led to a substantial increase in China's industrial added value share in the global economy, while Japan's share declined.
In 1992, Japan's government debt-to-GDP ratio was only 69%. By 2021, it had reached around 225%. The rapid growth in debt did not correspond to an economic recovery, indicating a very low multiplier effect. Therefore, Japan's case is highly worthy of in-depth reflection: Investment can be used to stabilize growth, but what should be invested in?
First, excessive investment in infrastructure with diminishing marginal returns is inappropriate, as it leads to massive waste, such as highways with insufficient traffic. Second, excessive investment in remote areas, where capital flow contradicts population flow, results in very poor multiplier effects. Third, there is a genuine need for forward-looking industrial policies. Government capital investment in manufacturing upgrades is essential; otherwise, global competitiveness will be lost.
Is it possible to reduce government leverage? Almost impossible. During a real estate downturn, both the household and corporate sectors are deleveraging. Only by increasing government leverage can economic balance be maintained. Japan's past lesson lies in the inconsistency of policies. When the economy was perceived as overheating, or when government leverage was deemed too high and fiscal revenue declined, attempts were made to reduce fiscal deficits by raising consumption taxes. As a result, fiscal policy shifted from expansionary to contractionary. For example, the Hashimoto administration, formed in early 1996, proposed the "Six Major Reform Principles" to address the lingering issues of huge fiscal deficits and public debt, which essentially entailed implementing fiscal contraction policies. In 1997, the consumption tax rate was raised from 3% to 5%, certain tax cuts were terminated, and the proportion of medical expenses borne by individuals was increased.
From the cases of developed economies, once they enter deep aging (aging rate exceeding 14%), government debt ratios invariably rise, and economic growth rates invariably decline. Therefore, reducing government leverage can only be temporary; the long-term trend is upward. The key is to use public expenditures effectively. Japan primarily focused on infrastructure investment, while the United States mainly focused on increasing household income and stimulating consumption. The U.S. model is clearly superior to Japan's.
The macroeconomy is a large system, so it is essential to cultivate the habit of systems thinking. For example, increasing investment can stabilize growth, and expanding consumption can also stabilize growth. However, blindly increasing public investment can lead to economic structural imbalances, where supply exceeds demand. In Japan's economic stimulus efforts during the 1990s, insufficient investment was directed toward boosting consumption, which was the root cause of long-term deflation. Even after Abe proposed a 2% inflation target in 2012, Japan still did not escape deflation, as household wage growth remained sluggish.
Lessons from others' experiences can help us improve our own.
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