DR-CHN-MACRO-COLLAPSE: Report on comprehensive analysis of China's economy "collapse"

Executive Summary: The Unraveling

Danger Map

Based on the assumption that the Chinese economy has entered an irreversible collapse process, this report analyzes its dynamics using four interrelated vectors. Starting with the conclusion that the previous report DR-CHN-MACRO-WINTER-GAMMA's "unwintering possible," the focus of the analysis shifts to the very mechanism of collapse.

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Practical Implications and Recommended Actions (Actionable Intelligence Summary)

The analysis shows that the Chinese economy is falling into an uncontrollable collapse spiral, with its effects becoming cyclone-shaped in the financial, resource and industry layers. We recommend that you implement the following strategic actions immediately:

• Financial Hedging:

  • currency: As a core strategy, we will establish a position that combines short offshore yuan (CNH) with long Japanese yen (JPY). After the collapse of the yuan, it is highly likely that the only reliable payment currency anchor in Asia is the Japanese yen, from the perspective of foreign net assets, capital freedom, and the rule of law.

  • assets: Eliminate China-related equity and bond exposures immediately.

• Credit Risk Management:

  • Credit: Immediately freeze or significantly reduce all China-related credit lines. For existing exposures, a provision will be recorded based on the assumption that a haircut of 50-70% is to be cut. LGFV, the real estate sector, and some state-owned enterprises should be considered as effectively in default.

  • Trade partner: Transactions with financial institutions within China will be kept to a minimum, taking into account settlement risks.

• Supply Chain Realignment:

  • Procurement: The company will accelerate its "de-China" approach, and fully move its procurement and production bases to India and ASEAN countries. This movement is already accelerating.

  • settlement: New contracts will also reduce reliance on the US dollar, and will introduce payments denominated in Indian rupee (INR), Singapore dollar (SGD), and Japanese yen (JPY) to diversify currency risk.

• Contingency Planning:

  • Humanitarian Corridor: Evacuation plans for expatriates and their families within China will be updated and standards for invocation are clarified. The triggers include the introduction of strict capital controls, restrictions on foreign currency withdrawals from banks, and the occurrence of widespread social unrest.

Part I: The Point of No Return: From Financial Winter to Systemic Collapse

The advance report, DR-CHN-MACRO-WINTER-GAMMA, analyzed the structural challenges facing the Chinese economy, concluded that "overwintering is not possible (95-99%)." This report uses this final judgment as the starting point for analysis. The focus is no longer on the "perfect" question of whether the Chinese economy can overcome this winter. The core of the analysis is to unravel the mechanism and timeline of the "collapse process" of the economy itself that has already begun.

The events that have emerged in recent weeks are not merely recession or financial crisis, but rather appear to be a more serious "regulation collapse." The central point of this report is the fact that the Chinese economy has fallen into a loop of self-proliferation collapse. This loop is driven by the interaction of the following four elements and amplifying each other:

1. Fiscal Insolvency: The "expanded government balance sheet," which includes hidden local government debt, has already deteriorated to an irreparable level. The only solution chosen by the authorities, fiscal finance by the central bank, fundamentally destroys the credibility of the currency (renminbi) and paves the way for hyperinflation.

2. Resource Scarcity: Due to the "scissors crisis," which is simultaneously declining export competitiveness and a substantial depletion of foreign currency reserves, the ability to continue importing strategic supplies such as crude oil, which is the lifeblood of economic activity, is becoming structurally lost. Strategic stockpiles were merely a life-prolonging measure, and fell into finite attrition assets.

3. Governance Failure: The Xi Jinping administration's political intervention and strengthened control in financial markets paralyzed the market's price discovery capabilities and efficient capital allocation mechanisms. Policy decisions, which prioritize the Communist Party's financial and political convenience over financial stability, have become a device that amplifies systemic risk rather than suppress it.

4. Industrial Decay: In parallel with the collapse of the macro level, the "credit capital," which forms the core of Chinese manufacturing, is collapsed at the micro level. Quality disguise, disregarding safety standards, and sloppy after-sales service are no longer individual fraud cases, but rather structural pathology that prevails throughout the industry. This undermines the export competitiveness, which is the source of foreign currency acquisition, from within, and further accelerates the above three collapse vectors.

These elements are no longer independent issues, but rather closely intertwined communities of fate. Fiscal finance will damage the value of the yuan, leading to import inflation, and exacerbate resource constraints. Resource constraints will stagnate production activities, reduce exports, and lead to further foreign currency shortages and fiscal deterioration. Failure of governance completely destroys market trust by making rational solutions to these problems impossible and making them ad hoc and political responses. And the collapse of industrial trust ultimately marks the end of the entire system by rendering the brand "Made in China" worthless and blocking the path to foreign currency acquisition.

The very response of policymakers has now become the main accelerator of collapse. Intensifying fiscal finance and political control exponentially increases the energy of long-term collapse in exchange for short-term life extensions. We are witnesses of a chain reaction that has become out of control.

Part II: The Solvency Crisis: Fiscal Dominance and the Devaluation Trigger (S1)

The essence of the crisis facing China is not a problem of liquidity, but a problem of insolvency. The nation's true debt is permanently outweighed its ability to repay, and the ban on fiscal finance, chosen by the authorities to cover this structural imbalance, has inevitably rendered a significant devaluation of the yuan. Financial independence was lost, and central banks became slaves to finances. This is nothing more than an overture to the collapse of the currency.

2.1 Recalibrating China's True Debt: The Expanded Government Balance Sheet

Public debt statistics published by the Chinese government only reflect a small portion of the debts the country faces, and significantly underestimates the reality. To understand the true risks, it is necessary to re-estimate the huge off-balance sheet debts posed by thousands of local government loan platforms (LGFVs) established by local governments, as well as contingent liabilities caused by state-owned enterprises (SOEs) and the real estate sector.

According to the International Monetary Fund (IMF) estimates at the end of 2022, LGFV's debt balance reached approximately 57 trillion yuan, comparable to the official debt balance of 61 trillion yuan, which includes central and local governments. At this point, the official debt to GDP ratio appears to be 51% at first glance, but when including LGFV debt, government debt in a broad sense is well above 100% in GDP ratio. Still other analyses suggest that, including LGFV bank borrowing and shadow banking, local government total debt could reach between 90 trillion and 110 trillion yuan, or 75% to 91% of GDP in 2022. The existence of this huge "hidden debt" indicates that China's financial situation is far more severe than its published value. In fact, the IMF already warned in its 2018 fiscal surveillance report that the net financial assets of China's general government had dropped to about 8% of GDP, mainly due to LGFV borrowings and poor performance of state-owned enterprises.

The authorities' main response to this structural problem is debt swaps through the issuance of "special refinance bonds." This refinances LGFV debt, which has been struggling to repay due to high interest rates, into official local government debt with lower interest rates. Although this policy has the effect of avoiding the short-term financial crisis of LGFV default, it does not fundamentally resolve the problem. Rather, it is merely an accounting operation that transfers the debt itself from the off-balance sheet to the on-balance sheet. This process officially certifies the state's obligation to rescue, which has previously been nothing more than an "implicit guarantee," and encourages serious moral hazards. In fact, hidden debt has grown again after past debt swaps, and as long as the fundamental distortions of local government revenue structure and central and local fiscal relations are preserved, this problem is unsolvable. This is nothing more than an act of turning a corporate-level credit crisis into a more serious national-level solvency crisis.

Table 1: China's Consolidated Debt Charge Estimates (2020–2025E)

Note: LGFV and hidden debt figures are integrated and estimated based on estimates from each institution. The GDP ratio is the ratio to nominal GDP.

As shown in this table, China's true government debt has already exceeded 100% of GDP and has entered a dangerous waters. This is an unsustainable level amid slowing economic growth and increasing deflationary pressure.

2.2 The Monetization Engine: The PBoC's Surrender to the Ministry of Finance

In front of a mountain of unrepayable debt, there is only one path left for the authorities. It is "fiscal finance" in which the People's Bank of China (PBoC) directly and indirectly assume government debt. This policy shift means a complete loss of PBoC's independence, tantamount to abandoning the central bank's fundamental mission of maintaining currency values.

Officially, direct underwriting of government bonds by PBoCs in the primary market is prohibited by law. However, in 2020, discussions over this "forbidden measure" have already been continued beneath the surface, with senior think tank executives under the Ministry of Finance already making proposals to take the matter directly, including legal amendments. It has now been reported that the joint working group between the Ministry of Finance and PBoC have discussed resuming government bond trading, and expectations are rising in the market for PBoCs to buy government bonds in the secondary market (effectively quantitative easing). This suggests that the shift towards fiscal finance is no longer merely becoming a debate, but rather as a formal policy option.

However, what's even more serious is stealth monetization, which has already become a norm. The aforementioned LGFV debt swap is a typical route. This process goes through the following steps: (1) Local governments issue "special refinance bonds" to rescue the insolvency of LGFV debt. (2) Large state-owned banks are instructed to purchase these bonds under political pressure, effectively converting bad debts into government debt. (3) PBoC accepts these bonds as collateral through means such as open market manipulation (OMO), medium-term lending schemes (MLFs), and lowering the reserve ratio (RRR), and provides ample liquidity to the banking system. This sequence is the very structure in which central banks indirectly finance the government's fiscal deficit as the ultimate lender. Monitoring the "claims on government" section on the PBoC's balance sheet and the trend in liquidity supply to the banking system is extremely important in measuring the scale and speed of this stealth monetization.

This mechanism transforms the entire financial system into a huge sponge that can absorb government budget deficits. Banks lose incentives to make sound credit decisions, and their assets expand with politically determined, low-yield government debt. This significantly undermines the efficiency and soundness of the financial system and sows the seeds of a larger financial crisis in the future. The PBoC is no longer a driver of independent monetary policy whose mission is to stabilize prices, but has now become a printing press that supplies currencies infinitely in accordance with the wishes of the Ministry of Finance.

2.3 The Yuan's Fragile Floor: Devaluation Triggers

The inclination towards fiscal finance has damaged the yuan's credibility both domestically and internationally, and has rapidly increased the risk of currency crashes. The stability of the yuan market is nothing more than a sham stability that has been barely maintained by authorities burning foreign currency reserves and tightening capital regulations. Several key trigger metrics need to be monitored to detect early signs of this vulnerable balance collapse.

The first indicator is the price difference (spread) between the onshore yuan (CNY) and the offshore yuan (CNH). While CNY is under strict domestic control, CNH is more likely to reflect market momentum. The phenomenon of CNH significantly cheaper (increasing spreads) against CNY is a clear signal that indicates increased capital outflow pressure and a decline in international confidence in the yuan. During past crises, this spread has served as a leading indicator of the limits of authorities' ability to intervene.

Second, it is the "substantial" rate of decline in foreign currency reserves. China's publicly announced foreign exchange reserves of around 3.2 trillion to 3.3 trillion US dollars contain statistical tricks to make it seem like an over-sized one. These include many assets that are extremely low in liquidity or cannot be exchanged in emergencies, such as stockholdings in foreign companies through China Investment Limited (CIC), and claims that have been loaned to developing countries under the Belt and Road Initiative and are virtually uncollectable. Furthermore, it is estimated that domestic banks' "available" foreign currency reserves, minus the implicit guarantees of dollar-denominated liabilities, are far less than the published value. Therefore, what is noteworthy is not the absolute amount of the published value, but the pace of decline in current assets such as US Treasury, which can actually be sold due to foreign exchange intervention.

In this regard, the third indicator is the seemingly contradictory movement of China's decline in US bond holdings and the accumulation of gold reserves. According to statistics from the US Treasury Department, China's US Treasury holdings are on a downward trend, with the most recent trending at around $750 to $770 billion. Meanwhile, PBoC has been consistently purchasing gold for over 10 months. This portfolio reallocation is more than just an asset management optimization. This is an extremely strategic and defensive action, assuming the intensification of the US-China conflict, selling dollar assets (US bonds) that could be frozen or confiscated by the United States, and escaping them into physical assets (gold) that are not affected by any financial sanctions. This move is the best evidence that the Chinese leadership is seriously considering and preparing for the future of exclusion from the dollar-centric international financial system. It is not an action to raise the yuan's international credibility, but rather a hopeless preparation prepared to leave the dollar system and isolated. This speed of US Treasury sales is one of the most important barometers that authorities recognize as critical urgency.

Part III: The External Constraint: The Closing Jaws of the Resource Crisis (S4)

The collapse of China's economy is not solely due to domestic financial and fiscal issues. The "scissor crisis," where two blades approach simultaneously - the structural deterioration of the ability to acquire foreign currency and the demand for foreign currency, which is essential for importing energy resources, is accelerating the collapse from outside the system. The ability to earn foreign currency has declined, and the need to use foreign currency will not decrease. This fatal supply and demand gap is no longer sustainable.

3.1 The Foreign Currency Vise: The Crude Oil Cash Cycle

China's export-driven growth model has entered its final stage. The export competitiveness, which was the source of foreign currency acquisition, is rapidly eroding due to the collapse of industrial credit (Part V) as described below and the slowdown in global demand. Along with this decline in revenue, foreign currency expenditures for crude oil imports, which are essential to maintaining economic activity, remain high. This structural imbalance becomes clearer by analyzing the crude oil cash cycle.

China's oil industry has relied on a business model of earning foreign currency by importing crude oil, refining it domestically, and re-exporting some as petroleum products. However, this model is subject to multiple pressures. Data for 2024 shows that crude oil imports fell 1.9% year-on-year to 11 million barrels per day (Mb/d), while oil products exports fell 7.2% year-on-year to 58.14 million tons, which fell at an even higher pace than imports. This suggests that the profitability of the refining and reexport business has deteriorated due to sluggish domestic demand and the deterioration in refining margins. Singapore's refinement margin is an important indicator of profitability across the Asian region, and keeping a close eye on the trends in this indicator is essential in assessing China's petrochemical sector's ability to generate foreign currency.

To purchase crude oil, whether it is a spot market or a long-term contract, it requires a large amount of foreign currency advance payments and the establishment of letters of credit (L/C). This initial funding cost is only increasing as foreign currency reserves drop substantially and yuan confidence falls. Once a wealth of trade surplus had made this cycle smoothly, but now its engine is on the verge of shutting down. A negative spiral has begun, where a decline in foreign currency revenue constrains the ability to buy crude oil, leading to a stagnation of production activities and further decline in exports.

3.2 Strategic Reserve Countdown: A Finite Buffer

In critical situations, the strategic petroleum reserve (SPR) serves as the final cushioning material. However, it is not an infinite resource, but a finite asset that will certainly deplete over time. If its ability to earn foreign currency continues to deteriorate at the current pace, China will soon be forced to turn SPR into a normal state in order to cover domestic consumption.

The exact size of China's SPR is state secret, and published data is fragmentary. As of 2024, external agencies estimates it is approximately 290 million barrels, but the government's official target has been set at approximately 500 million barrels, equivalent to 100 days' worth of imports. In peacetime, this stockpile contributes to responding to price fluctuations and stabilizing the supply network, but when faced with the structural crisis of imports being cut off due to a shortage of foreign currency, its role will change to simply a "life extension device."

The following simulation estimates the timeline of SPR depletion under various stress scenarios.

• Baseline scenario: Assuming that the trends in current import volume (approximately 11 Mb/d) and domestic consumption continue. Even in this case, it may be necessary to slowly rescind the stockpile to compensate for the decline in domestic production.

• Import disruption scenario: We expect cases where growing geopolitical tensions (e.g. Taiwan's emergency) and financial sanctions by Western countries will result in partial blockage of maritime transport routes, resulting in a 20% to 40% reduction in crude oil imports. In this case, assuming that the shortfall is completely compensated with SPR, the stockpile will rapidly decrease and reach the dangerous waters within a few months to a year.

• Price shock scenario: We expect that crude oil prices will rise 50% due to global supply concerns. This will result in a 1.5-fold increase in foreign currency required to import the same amount of crude oil, resulting in a serious foreign currency shortage. As a result, they are forced to reduce import volumes, and reliance on SPR is increased, just like in the import disruption scenario.

What these scenarios illustrate is the fact that the time grace provided by SPR is extremely limited. Stockpiling does not solve the problem, it simply puts off. And the clock is definitely moving forward. The number of days remaining in stockpile and the ratio of spot and long-term contracts (an increase in spot ratio suggests a decline in creditworthiness and foreign currency capabilities to enter into long-term contracts) are important KPIs to measure the progress of this countdown.

3.3 The Petro-Yuan Mirage: A Non-Viable Alternative

Faced with the structural constraints of a foreign currency shortage, China is promoting its "Peter Renminbi" concept, namely, as a national policy, to shift the settlement of oil transactions from the US dollar to the yuan. However, this concept is less than a realistic alternative to dollars, rather than a geopolitical propaganda. There are structural barriers that are difficult to overcome to establish the yuan as an international resource settlement currency.

It is true that yuan settlements are expanding in bilateral transactions with countries under Western financial sanctions, such as Russia and Iran. However, this is merely accepting the yuan with no other options by countries excluded from the dollar payment system. This is a "system of necessity," not a global "system of choice." Due to strict capital restrictions, the yuan received by these countries cannot be freely exchanged for other currencies, and its use is limited to purchasing Chinese products.

Meanwhile, major oil-producing countries, including Saudi Arabia, with access to the dollar system, are extremely reluctant to move to renminbi payments in earnest. The reason is clear. First, for Gulf countries that pegged their currency into the US dollar, receiving oil revenues from the highly fluctuating yuan means taking significant foreign exchange risks. Secondly, the yuan received is limited to limited financial products within China, and is significantly inferior to dollar assets in terms of liquidity and safety. Third, the yuan-denominated crude oil futures market (Shanghai International Energy Exchange) remains low in liquidity and concerns about the risk of government intervention in pricing, and has not achieved credibility as an international benchmark.

The data published by SWIFT confirms this reality. The yuan's share of international payments remains low, with the recent past surpassing the Canadian dollar, falling to sixth in the world, with its share falling to less than 3%. Although its share in trade finance is on the rise, it is far from threatening the US dollar's stronghold, which is the king of settlement currency.

In conclusion, the Peter's yuan initiative has no more meaning than creating a closed bartering system within a small China-led anti-American and anti-dollar alliance. It does not have the ability to provide global, highly liquid payment methods to ensure stable ensuring the enormous amount of energy resources China needs, and does not have the ability to solve the fundamental problem of a foreign currency shortage. Despite the grand narrative of the challenge to dollar hegemony, this is just a sign that highlights the seriousness of the external constraints China faces.

Part IV: The Governance Implosion: Political Paralysis of the Market (S6)

The collapse of the economy is accelerated not only by market failures, but also by failings in governance. In today's China, the reinforcement of absolute control over the economy by the Communist Party is deliberately destroying the underlying mechanisms of the market economy: efficient allocation of capital and fair pricing of risk. Rather than delaying problem solving, this political intervention has become an engine that drives the collapse process itself.

4.1 The Wu Qing Effect: The Chilling of Capital Markets

In February 2024, the head of the China Securities Regulation and Control Committee (CSRC) was replaced by Yi Huiman, a hardliner who was considered relatively market-oriented, to Wu Qing, a hardliner nicknamed "broker butcher of a securities company," marking the complete shift in policy from market development to political discipline. This personnel matters under the pretext of energizing a sluggish stock market, in fact, is a strong indication that the party will further strengthen its control over the market and not allow any "deviation."

The impact of this policy shift is most dramatically reflected in the initial public offering (IPO) market. The reforms to a registered IPO that emphasizes market principles, which were carried out under the full capacity of the Economy Party, were effectively erode with Wu Qing's appointment. After taking office, Wu Qing promised to "oversee the entire process" of IPO reviews, and as he said, CSRC announced in 2024 that it would conduct on-site inspections on at least 25% of IPO application companies. This is a five-fold increase from the 2023 5% target. Furthermore, the new guidelines make it clear that strict supervision and control will be prioritized over market development.

This sudden tightening of screening has resulted in a serious "chilling effect" on the IPO market. In early 2024 alone, 47 companies withdrew their IPO applications, increasing sharply from 29 companies in the same period last year. This shows the reality that businesses and underwriting securities companies are forced to give up on listing plans themselves, facing new political risks and an unpredictable screening process.

The authorities' aim is to improve the supply and demand balance by artificially narrowing down new stock supply and supporting the stock prices of existing stocks. However, this is an extremely myopic policy that paralyzes the most important function of the market: capital allocation. The de facto halt of the IPO market will take growth capital from innovative startups and close the exit strategies for venture capital and private equity that have invested in them. This also contradicts the national strategy of aiming for technical independence. Above all, this policy sends a strong message to domestic and international investors that in China's capital markets the political will determine everything, rather than economic rationality or corporate growth potential, and fundamentally destroys trust in the market. A market that has ceased capital allocation functions can no longer be called a market, but is merely a tool of political control.

Table 2: Trends in the rate of withdrawal and cancellation of IPO applications (comparison of Wu Qing's appointment before and after he took office)

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Note: The figures are estimates from this report based on public information and information from market data providers (such as Wind Information).

4.2 The Primacy of Politics: Fiscal Needs over Financial Stability

Currently, policy-making priorities in China are not the stability of the financial system or the long-term health of the economy. It is an extremely political goal of meeting the Communist Party's financial needs and maintaining social stability. This policy blueprint of "Fiscal Priority> Financial Stability" can be clearly seen in all fields.

Responding to the LGFV debt problem is a typical example. If financial stability is truly considered, then insolvency should resolve LGFVs, who have fallen into settlement, share losses with those involved, and restore market discipline. However, the authorities chose to avoid financial collapse of local governments at the expense of the soundness of financial institutions, by forcing the banking system to refinance bad debts. This is nothing more than a result of the financial system being willing to amplify systemic risks and prioritizing short-term political stability.

The corruption crackdown campaign underway in the financial industry is not just a disciplinary purge. As symbolized by the investigation of former CSRC head Iekai Man, this is a political purge that removes technocrats who believe in market principles from the financial system and places people who are loyal to the party's wishes. The purpose is to fully take control of financial institutions as the party's "wallets" and create a system in which political orders such as fiscal finance and relief from state-owned enterprises can be implemented without any resistance.

Under such a governing system, policy decisions based on economic rationality cannot be expected. All policies are subordinate to the absolute propositions of "party leadership" and "national security." Markets are stripped of their role as an autonomous mechanism and degraded into tools to achieve party policy goals. This process inevitably prepares a path that deprives the market of vitality, conceals and accumulates risks, and ultimately leads to sudden death of the entire system.

Part V: The Hollowing Out: Quantifying Industrial "Credit Capital" Destruction

The collapse of the Chinese economy is not just about the deterioration of macroeconomic indicators. Deep down there, the most important intangible assets that have supported China's export-driven model, namely "credit capital," is beginning to collapse. This destruction of credit capital, consisting of factors such as quality, safety, reliability and accountability, is no longer a scandal of individual companies, but a structural corrosion of the entire industrial system. This chapter quantifies this invisible asset collapse and reveals how it is eroding China's last lifeline, its ability to acquire foreign currency.

5.1 The Credit Capital Impairment Index (CCII)

To specifically measure the abstract concept of industrial credibility collapse, this report proposes its own "Credit Capital Impairment Index (CCII)." This is a synthetic index that aims to capture a multifaceted decline in international trust in Chinese manufacturing, and consists of four main components:

1. Product Safety & Recalls:

   • Definition: The number of Chinese products recalls and their severity as published by major export market regulators (EU, US, etc.) such as EU Safety Gate/RAPEX, FDA, etc.). In particular, the company will focus on monitoring major export sectors such as electric vehicles (EVs), smartphones and related electronic devices, and medical devices.

   • Implications: The rise in recall rates is direct evidence that product quality control and safety standards do not meet international requirements.

2. Insurance & Warranty Costs:

   • Definition: The percentage of loss rates (payment claims ÷ premiums received) for property and loss insurance in a particular product category (particularly EV) and the sales ratio of product guarantee provisions recorded in the financial statements of listed manufacturers.

   • Implications: The worsening loss rate and the increase in guarantee costs are objective financial data showing that product failure rates and accident rates exceed market expectations, and are financially quantifying poor quality.

3. Disclosure Quality:

   • Definition: Frequency of revisions to past financial statements by listed Chinese companies. This serves as a proxy for the reliability and transparency of accounting information.

   • Implications: The high frequency of revision of financial statements suggests that there is a prevalence of a corporate culture where there is a lack of awareness of compliance with accounting standards and lack of reliability in disclosure information.

4. Consumer & Media Sentiment:

   • Definition: We analyze the frequency and spread of scandals relating to product quality, after-sales service defects, and data fraud on social media in China such as Weibo through OSINT (Open Source Intelligence).

   • Implications: Real consumer voices and reporting are important in measuring the actual situation of quality issues that cannot be captured by official statistics and the degree to which brand image is damaged.

By combining and indexing these indicators, CCII will act as a dashboard for continuous monitoring of the "health" of Chinese industry's credibility.

5.2 Case Study I - The EV Debacle: From Subsidy Fraud to Systemic Failure

China's EV sector is a symbol of a national strategy that has grown rapidly due to huge government subsidies, but in fact it is a sandy tower filled with quality disguise and institutional failure. This sector collapse is a typical example of credit capital damage.

The roots of that corruption are deep. In 2016, a large-scale subsidy fraud by EV manufacturers was discovered. The method was malicious, such as registering "paper cars" that were not actually produced to steal subsidies, or replacing them with large-capacity batteries in model certification tests, and replacing them with cheaper, smaller batteries in actual mass-produced vehicles. The incident shows that from the early days of the sector there was a ingrained culture of fraud that prioritized subsidies over quality and performance.

This structural defect is currently erupting in the form of a collapse in the safety and reliability of the product. In 2023, the number of EV recalls in China rose 32.3% from the previous year to 1.6 million units. The main causes were "electrical system problems" such as the risk of battery fire and sudden loss of power, and "difficulties with smart functions" such as autonomous driving assistance systems.

The most objective and fatal evidence of this quality collapse appears in data from the auto insurance market. In 2024, China's new energy vehicle insurance division recorded a massive underwriting loss of 5.7 billion yuan. Surprisingly, according to data from the China Settlers Association, out of the 2,795 models undertaken by insurance companies, a total of 137 models have a loss rate of over 100%. This means that for these vehicles, there are more insurance benefits paid than the insurance companies receive.

From an actuarial perspective, a loss rate exceeding 100% is an abnormal situation. This indicates that real data completely overturned the risk assessments that insurance companies had assumptions about accident rates, breakdown rates, and repair costs. This is not just an insurance company's management issue. Market mechanisms are equivalent to branding these EVs as "failed" because they have fundamentally defects from the design and manufacturing stages, are dangerous on the streets, and have an unusually high repair cost. The EV insurance crisis is a financially proof of the systemic failure of quality control, safety design, durability and after-sales service networks throughout China's EV industry.

5.3 Case Study II - The Façade of High-Tech: Smartphones and Medical Devices

The collapse of credit capital is not limited to the EV sector. Similar corrosion is taking place in other high-tech sectors where China holds a key position in the global supply chain.

Smartphone: Once rated as "cheap and high performance," Chinese-made smartphones now suffer from a reputation for software instability, insufficient after-sales service and security concerns. Consumers have pointed out issues such as excessive data collection using pre-installed apps and neglecting vulnerabilities due to delays in OS updates. In Europe, it was discovered that a censorship list was pre-installed on Xiaomi smartphones, causing a major problem. Additionally, the EU's Safety Gate (RAPEX) product safety warning system has frequently been recalled to China-made USB chargers as risk of overheating or ignition, and there is a questionable mark on quality control across the ecosystem, including peripheral devices.

Medical Devices: In the field of medical devices that are directly linked to human life, damage to credibility is also serious. The US Food and Drug Administration (FDA) has issued warnings to Chinese medical device testing agencies of forgery and replicating clinical trial data. This shakes the reliability of the product approval process itself. In fact, FDA and EU databases have seen many cases where medical devices manufactured in China are recalled due to poor quality or safety issues. For example, the reasons include inadequate sterilization treatment, damage to parts, and inability to meet performance standards. These cases suggest that Chinese medical device manufacturers face fundamental challenges in terms of international quality control standards (QMS) and regulations.

5.4 Economic Impact Model: From Lost Trust to Lost Dollars

Damage to credit capital is not just an intangible loss of deterioration in brand image. This directly leads to concrete economic losses, such as lower export prices, increased transaction costs, and ultimately a loss of market share.

The model in this report quantifies the negative impact of the aforementioned rise in the Credit Capital Damage Index (CCII) on China's export competitiveness. As CCII deteriorates, the following chain reaction occurs:

1. Decreased price negotiation power: Overseas buyers will be taking into account quality risks and demanding greater discounts. This reduces the average unit price and profit margin of exported products.

2. Increased transaction costs: Buyers will now require stricter quality inspections and third-party audits. This will result in Chinese exporters being borne by additional compliance costs.

3. Rising insurance and guarantee costs: Premiums for export credit and product liability insurance will rise, putting pressure on companies' costs.

4. Exclusion from the supply chain: Ultimately, risk-averse global companies will switch their sources from China to more reliable countries and regions, such as India and ASEAN.

This process structurally reduces China's ability to acquire foreign currency, further increasing the "external resource constraints" discussed in Part III. The collapse of credit capital interacts with macroeconomic instability, leading the Chinese economy to an irreparable decline.

Part VI: Scenarios, Timelines, and Strategic Response

The analyses so far are combined to present a highly probable scenario regarding the collapse process of China's economy, and propose concrete and viable strategic measures to overcome this unprecedented situation.

6.1 Base Case Scenario (75% Probability): The Unraveling (H2 2025 - 2027)

The most likely scenario is an "chain of collapse" out of control.

• trigger: The financial deterioration of local governments has reached its limit, and the fiscal financing of PBoCs will expand to an unconcealable scale. The market has completely seen the yuan's confidence, and selling yuan accelerates at once both domestically and internationally.

• process:

  1. Currency Crisis (H2 2025): The authorities initially attempted to intervene in exchange for foreign exchange reserves by incorporating a large amount of foreign currency reserves, but failed due to a substantial depletion of reserves. CNH prices plummet, and the spread with CNY expands to an unusual level. Eventually, authorities are forced to cut sharply or move to a floating exchange rate system (de facto Depegg).

  2. Import Inflation and Hyperinflation Eve (2026): The yuan crash has caused a sudden rise in prices of imported goods, including energy and food. Domestic production activities are paralyzed due to rising costs of imported raw materials and the disruption of supply. The sudden rise in currency supply and the collapse of domestic production begin to appear as hyperinflation.

  3. Social confusion and regime rigidity (2026-2027): Severe inflation and shortages of supplies cause massive social unrest. The government will respond to this with price controls, distribution systems and a more stringent social and political surveillance system. Economic activity is completely stagnant and a retrograde approach to a planned economy begins.

• Ending: Authorities will introduce strict North Korean capital controls after the currency has lost most of its value. People's assets are effectively contained within the country, and they are forced into economic hardships along with currency that has been devalued. China is effectively separated from the international economic system.

6.2 Tail Risk Scenario (20% Probability): The Iron Cage (2025)

Although it is lower than the base case, it should also be considered as a faster and more destructive scenario, authorities may take preemptive action to prevent a currency crisis.

• trigger: The leadership decides to introduce full capital controls as a precaution before the attrition of foreign currency reserves reaches a critical point.

• process:

  1. Complete Capital Blockade (H1 2025): One day, overseas remittances, foreign currency exchanges, and purchasing overseas assets by individuals and businesses are suddenly completely prohibited. This will temporarily avoid a crash in the yuan, and the remaining foreign currency reserves will be preserved for the national strategic purposes (minimum imports of military, food and energy).

  2. Supply Chain Necrosis (H2 2025 - 2026): However, this measure is equivalent to breaking the lifeline of the private economy. All industries that rely on imported parts, technology and licenses will be forced to halt production activities. Foreign companies begin withdrawing at once, and domestic supply chains are cut off and rapidly necrotic.

• Ending: In exchange for maintaining the value of currency, the real economy rapidly contracts and collapses. The unemployment rate will explode, leading to similar social unrest and regime stiffness as in the base case, but the process will progress in a shorter period of time. This is a scenario where you choose to die of suffocation.

6.3 Actionable Recommendations

Regardless of which scenarios become reality, their impact is devastating. The following recommended actions are essential to minimizing losses and surviving the upcoming confusion.

• Financial hedge:

  • Currency Strategy: Based on the analysis of this report, the core hedging strategy will be the combination of CNH short and JPY long. Japanese yen will be the only "flight to quality" service in Asia. This is due to its position as the world's largest foreign net worth country, its completely liberalized capital accounts, and its financial markets backed by the rule of law. If capital flight from the yuan begins to fully begin, some of them will inevitably head towards Japanese yen.

  • Action Plan: Use CNH/JPY currency options and futures to build positions that are prepared for tail risk.

• Credit Risk Management:

  • Credit Reduction: China-related credit lines should be reviewed immediately, even if the counterparty is a state-owned enterprise or a major bank. Implicit government guarantees are worthless in situations where the solvency of the government itself is questioned.

  • Reserve: Existing claims to China are deemed to have a very high probability of default and a large allowance for doubtful accounts will be recorded.

• Supply Chain Redesign:

  • Relocation of base: The "China Plus One" strategy is no longer sufficient. We should begin a radical restructuring of the supply chain, with the premise of "China Exit." The most prominent relocations are India and ASEAN countries, which combine geopolitical stability, labor abundance and domestic market growth.

  • Diversification of payment currencies: In contracts with new suppliers, the settlement currency will not be limited to US dollars, but will actively utilize Indian rupee (INR), Singapore dollars (SGD), Japanese yen (JPY), and more. This also allows us to distance ourselves from US monetary policy and geopolitical risks.

• Crisis Management Plan:

  • Humanitarian Corridor Preparation Standards Updated: Ensuring the safety of employees will be our number one priority, and the criteria for invoking evacuation plans will be linked to more specific and early signals. For example, an objectively observable trigger is set, such as "if foreign currency withdrawals are suspended at a bank counter for two business days in a row" or "if a measure similar to martial law is issued in a major city."

The collapse of the Chinese economy is no longer a risk of a distant future, but an ongoing reality. Based on the analysis and scenarios presented in this report, taking swift and decisive action is the only way to overcome this historical turning point.

Appendices

Appendix A: Key Performance Indicator (KPI) Dashboard

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Appendix B: War Game Memorandum: Trigger-Based Response Protocols

the purpose: This memo outlines the response procedures (protocols) in the event of a particular critical event (trigger events) in the collapse process of the Chinese economy. Each protocol serves as a guide to conducting emergency management teams to make quick and rational decisions.

1. Trigger Event: Significant devaluation of the yuan/Depegg declaration

• Definition: The People's Bank of China will officially announce that it will cut the yuan's yuan's standard against the dollar by more than 5% in a day, or that it will abandon its controlled floating exchange rate system.

• Ready-to-read protocol:

  1. Financial Markets:

     • Immediately settle all CNH Short/JPY Long hedge positions and secure profits.

     • All remaining Chinese-related assets (stocks, bonds, real estate) will be sold immediately regardless of market value. If liquidity is depleted, the valuation loss is recorded as 100%.

     • Establish a short position for Asian regional currencies (excluding JPY) (preparing for contagion risk).

  2. operation:

     • Convert Chinese yuan-denominated deposits within China into foreign currency (USD, JPY) or physical assets wherever possible.

     • Suspends payments to suppliers and begins renegotiation for new terms of payment (foreign currency, advance payments).

  3. Crisis Management:

     • The evacuation plan alert level will be raised to "highest" and preparations for immediate evacuation for expatriates and families will begin.

2. Trigger Events: Introduction of Formal Capital Control

• Definition: Authorities will announce a significant reduction in the annual currency exchange and remittance cap for individuals and businesses, or an entire ban. Foreign currency withdrawals at bank counters will be effectively suspended.

• Ready-to-read protocol:

  1. Finance:

     • Funds from domestic Chinese corporations will be deemed fully captured and will be excluded from the consolidated balance sheet. All related assets will be impaired.

     • Assuming that there is zero chance of continuing the Chinese business, a business withdrawal plan will be formulated.

  2. supply chain:

     • All procurement from China will be suspended immediately.

     • An emergency production increase agreement will be concluded with an alternative supplier in ASEAN, India. Emergency transportation by air is also an option.

  3. Legal and Compliance:

     • Requires external lawyers for legal advice regarding asset protection and business withdrawal under capital control. Consider the possibility of termination of contracts under the force majeure clause.

  4. Crisis Management:

     • Immediately activate the evacuation plan.

3. Trigger Event: Public offering defaults for major state-owned banks or LGFVs

• Definition: The major state-owned commercial banks, or LGFVs, which have influence across multiple provinces, are unable to fulfill interest payments or redemptions on public offerings issued on the onshore or offshore market.

• Ready-to-read protocol:

  1. Credit Risk:

     • It is determined that China's entire financial system will fall into a systemic credit contraction.

     • We will immediately close derivative transactions with all Chinese counterparties (both financial and non-financial) to secure collateral.

     • The holdings of commercial papers, corporate bonds, etc. issued by Chinese companies will be reduced to zero.

  2. Financial Markets:

     • The company expects a sharp expansion in the Asian Credit Default Swap (CDS) index spreads, and will establish a protection buy position.

     • We predict that a large-scale financial escape will occur in safe assets (US Treasury, Japanese Treasury, Gold), and establish long positions in related assets.

  3. Intelligence:

     • Strengthen information gathering for signs of chained defaults to other financial institutions and LGFVs. In particular, we will be closely watching the sudden rise in interest rates (SHIBOR) in the interbank market.