Risk 7: China's deflation trap

China's deflationary spiral will deepen in 2026, and Beijing won't do anything to stop it. With the 21st Party Congress looming in 2027, Xi Jinping will prioritize political control and technological supremacy over the consumption stimulus and structural reforms that could break the cycle. Beijing has the means to prevent a crisis, but living standards will deteriorate, the fallout will spread abroad, and the world's second-largest economy will remain stuck in a trap of its own making.

Home prices in China have been falling for four and a half years—a household wealth destruction on par with America's 2008 crash, except it's still accelerating. Consumer confidence, investment, and domestic demand have cratered with it. Beijing bet big that high-tech manufacturing would fill the gap left by property. Instead, state-driven investment has created overcapacity, and weak domestic demand means there aren't enough buyers to absorb it.

The result is "involution": too many Chinese firms chasing too little demand, slashing prices to survive. Margins collapse, forcing even well-run firms to cut wages and jobs to stay afloat. Workers spend less. Demand weakens further, so firms cut prices again. Meanwhile, debts grow harder to service with each turn of the cycle. Banks and local governments keep zombie firms alive—rolling over loans, protecting local champions—which keeps overcapacity entrenched. The debt-deflation spiral feeds on itself. Donald Trump's tariffs last year made the situation worse, closing off a critical export market and confronting Chinese firms with a grim choice: slash prices to find buyers outside the United States, or transship goods through third countries to reach America anyway. Either path squeezes margins further. Over a quarter of listed Chinese companies are now unprofitable, the highest share in 25 years. 


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