The Chinese economy is in distress, and the country’s currency and markets, reflecting unease, are tumbling. Xi Jinping, the Chinese ruler, has no solutions. The only thing he is doing is incurring more debt.
That’s extremely unfortunate because an overly indebted Beijing is again set to push the world into recession. China, through predatory policies, precipitated the global downturn last decade, and it looks like it will cause the next one as well.
Last time, the Chinese benefitted handsomely from worldwide misery. This time, they will not be so fortunate and will almost certainly end up being the greatest victims.
On the surface, China’s economy looks fine. On Monday, the National Bureau of Statistics reported that gross domestic product increased 6.7 percent in the second quarter of the year, down from Q1’s 6.8 percent but in line with expectations.
Yet China’s growth rate, whatever is reported, is not the issue. The country has a fundamental problem: it is taking on debt fast. The country is incurring maybe one-and-a-half times as much indebtedness as it is creating nominal GDP—if the official GDP figures are accurate.
They are not accurate, however. The National Bureau of Statistics has been reporting steady GDP numbers, which would be extremely unusual in a fully mature economy, not to mention a developing one like China.
So Beijing’s numbers are, on their face, suspect. Take 2016, for which Beijing claimed 6.7 percent growth. The World Bank, in the middle of last year, released a chart showing that in 2016 China’s gross domestic product grew 1.1 percent.
The 1.1 percent figure, shocking to many, is in line with the single best overall indicator of Chinese economic activity, total primary energy consumption. In 2016, total primary energy consumption, according to official numbers, increased 1.4 percent.
In 2017, the economy picked up—energy consumption rose 2.9 percent—but GDP could not have grown by the claimed 6.9 percent.
Low growth highlights Beijing’s enduring problem: no economy can indefinitely continue to create debt faster than producing GDP, especially at China’s pace. At some point, there must be an “adjustment,” as economists would put it, and a “crisis” as the rest of us would describe it. Moreover, that adjustment, or crisis, has to be large because it has been delayed for so long.
Beijing has delayed adjustments since the 2008 downturn with perhaps the largest lendathon-spendathon in history. In the five years starting in 2009, Chinese banks extended an amount of credit that was roughly equal to that in the entire U.S. banking system, even though at the end of 2008 the Chinese economy was less than a third the size of America’s. The spree has continued since the end of that half decade.
The result is that the Chinese economy has become unbalanced, those imbalances have become threatening, and the country has accumulated an awesome amount of debt. In 2008, China’s debt-to-gross domestic product ratio, a standard metric for debt sustainability, was 141 percent according to Bloomberg. That figure was already worrisome, but the situation has rapidly deteriorated since then. The ratio, Bloomberg reported, had ballooned to 256 percent in the middle of last year.
The figure is undoubtedly higher, especially when the so-called “hidden debt” in the “shadow banking” system is counted. Andrew Collier of Hong Kong-based Orient Capital Research says shadow banks handle “almost half of all the money in China.” Taking into account all indebtedness, Collier believes the country’s debt-to-GDP ratio is about 400 percent. A percentage of that sort shows the country’s debt load is exceedingly burdensome.
China’s heavy debt is a drag on growth, especially because many of the investments made with the borrowings are unproductive. Some are unproductive because they were completely misconceived and will remain so or because they will become productive only far into the future. In either case, those investments cause a current-day problem. Chinese technocrats can do many things, but as Fraser Howie, co-author of Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise, told me last month, “What they can’t do is make crap investments good ones.”
China’s leaders have tried to outgrow problems by piling on more indebtedness. That stratagem worked at the end of the 1990s, but the accumulation of debt has now become so burdensome that it is slowing growth and shaking confidence.
Concerns about the economy, among other things, triggered massive capital flight in 2015 and 2016, when net capital outflow was, according to best estimates, slightly in excess of two trillion dollars. Beijing stopped the outflow, but only with draconian capital controls, only some of which were officially announced.
Despite the success in stemming outflow, concerns remain. Last October, Zhou Xiaochuan, when still head of China’s central bank, publicly raised the possibility that China would suffer a “Minsky Moment,” the point when asset values collapse. It is also the worry of the Chinese people, who obviously think something bad is coming. Survey after survey show that a third to a half of China’s wealthy plan to leave their country in the medium term.
As Zhou’s extraordinary comments indicate, Beijing’s situation remains serious. Michael Pettis of Peking University pointed out in comments at the Fortune Global Forum in December that the difference between China’s situation today and prior debt crises in other countries is that in those prior crises the economic imbalances were not as “deep” and debt was not as “high.”
China can get away with imbalances and debt longer than other countries. Beijing tightly controls borrowers, lenders, markets, courts, everything. Nonetheless, the economy cannot be far from that critical point when an adjustment occurs.
Why? Enter Donald Trump. Whether one thinks President Trump started a trade war or merely responded to the one China began—I vote for the latter interpretation—he is taking actions that attack the Chinese economy and shake confidence.
After an initial wave of propaganda-created bravado, Chinese academics and analysts are beginning to understand that the “trade war” is a long-term struggle that their country cannot sustain.
Why? Trump talks about trade deficits, but his administration’s actions are focused on technology. A tech struggle, more than a trade one, looks like a contest for the future. As Thomas Friedman of the New York Times wrote in early May, this is not a fight about tariffs or even about trade; this is a fight for the future. Friedman’s conclusion is not so much his own analysis but the views of Chinese sources. Many in China view this as, or almost as, an existential struggle. Americans, in time, will see it the same way.
In any event, Trump’s actions are putting severe pressure on the Chinese economy. “I actually believe that Trump’s determination to reduce the amount of U.S. dollars in circulation will induce a Chinese crisis, as you can see from current bond yields, the A-share stock market, and renminbi value,” Anne Stevenson-Yang, co-founder of Beijing-based J Capital Research, told the National Interest. “This is not a Trump intention but an effect of rising interest rates, partly a function of the tax giveaway, since borrowing so much more money raises rates, plus what will have to be a decline in U.S. trade. The reason this may spark the long-expected debt crisis is that the Chinese economy is very dependent on incoming U.S. dollars to support expansion of the money supply. Without that, they have to just print, and that’s inflationary.”
Chinese technocrats may be approaching the outer limits of what they can print to keep the economy going. At the end of last year, China’s M2, the broad gauge of money in circulation, amounted to $25.98 trillion, a whopping 202.3 percent of 2017 GDP. In comparison, America’s M2 at the time was $13.82 trillion, only 71.8 percent of GDP.
Trump is reducing the flow of money just when Beijing needs it most. The People’s Bank of China, the central bank, in recent weeks has been adding cash in a hurry. As Collier told the National Interest, Chinese officials have in general thought that recent tightening had gone too far and they also have tried “to respond to the impact of a trade war on the economy.”
And China, a trade-surplus country, is especially vulnerable to a trade war. The World Bank estimates that exports accounted for 19.8 percent of China’s 2017 GDP.
Collier does not expect a Chinese financial crisis, but the short-term move of adding credit will, he says, result in “more bad projects” and therefore “a weaker underlying economy.”
Beijing is in a bind. Adding credit will stimulate the economy and contain the ongoing wave of bond defaults. Yet more credit will weaken the renminbi, which fell a record 3.25 percent against the dollar in June and is continuing its decline. A weaker renminbi leads to capital outflow.
At the same time, the Federal Reserve is raising interest rates. Higher U.S. rates tend to trigger flows of money out of China and into America. The swamp Trump is draining is China.
And Trump’s actions on trade, along with Beijing’s response, will lead to a reduction in exports, hence reduced export proceeds.