China’s
Party Isn’t Over—That’s the Problem
The
country that stabilized the world in the aftermath of the financial
crisis now threatens to capsize it
By ANDREW BROWNE
Jan. 19, 2016 4:41
p.m. ET
In
the aftermath of the Wall Street crisis that brought down Lehman
Brothers in 2008, Chinese state capitalism came to the rescue.
Thank China for
constructing, in record time, the world’s most extensive high-speed
rail network, airports, subways and intercity highways. The frenzied
spending prevented the global economy from toppling into a
depression, argues the Nobel-winning economist Joseph Stiglitz.
Today, the mountain
of debt and massive industrial overcapacity dating from that
government-directed stimulus is often described as China’s
“hangover.” But the party hasn’t stopped. In fact, it’s
heating up.
Total debt has
ballooned from less than 160% of gross domestic product to nearly
260% now. More was added, relative to the size of the economy, over
the past 12 months than at the outset of the investment binge. Except
now China can’t absorb all the extra investment. Much of it is
going to waste, and companies are using new debt to pay off old.
The momentum hasn’t
flagged because Chinese leaders demand growth at all costs; though
the economy is successfully transitioning toward a consumption-driven
model, it can’t make up for lost growth in manufacturing and
investment.
Chinese state-owned
companies in industries like steel and coal are suffering from
declining profits and big debt loads. Here, a worker walks past a
pile of steel-pipe products in Tangshan in China's Hebei Province
late last year. PHOTO: KIM KYUNG-HOON/REUTERS
Economists have long
asserted that China can afford the profligacy. They note that the
government’s overall debt is modest, national savings is high, and
the debt is overwhelming in local currency so there’s no risk of
foreign creditors pulling out their money and triggering a classic
payments crisis.
These arguments now
sound like lullabies. As debt mounts, the markets have become
convinced that China’s day of reckoning is coming.
They are right. But
when? Investors are mistaken if they perceive a Chinese financial
crisis just around the corner. There’s no cause for immediate
panic. By some calculations, the current pace of debt expansion will
place China in the danger zone around five years from now. That’s
when the imbalances may start to resemble those of other East Asian
nations, like Indonesia and South Korea, before their financial
systems blew up.
But the science of
financial failure is unreliable. Japan, which appears capable of
growing its colossal pile of debt almost indefinitely without
provoking a crisis, underscores that point. In China’s case,
though, one thing is certain: Unlike the big debt binges the country
went on in the past, this time around it can’t grow out of its debt
woes. Debt is growing faster than GDP.
Much of it sits on
the books of state-owned companies in traditional industries—steel,
shipbuilding, coal, glass, cement—whose profits are declining.
Factory prices have been falling for almost four years.
Chinese state-owned
companies in industries like steel and coal are suffering from
declining profits and big debt loads. Here, a worker walks past a
pile of steel-pipe products in Tangshan in China'
The ironic result is
that the country that stabilized the world economy seven years ago is
now the source of impending turmoil—whenever, and however, that may
strike.
It’s precisely
this uncertainty that unnerves investors from Rio de Janeiro to
Jakarta. Rich Chinese who can pull their money out are doing so.
Mainstream economists, not just China doomsayers, are starting to
adjust their forecasts for the possibility that China will never ease
up on lending, that debt will just keep stacking up until it
collapses under its own weight.
Maury Obstfeld, the
International Monetary Fund’s Economic Counsellor and Director of
Research, nodded to the risks inherent in China’s attempts to
squeeze growth out of an exhausted industrial machine in his recent
survey of the 2016 global economy. China’s “time-honored methods
of enforcing growth targets,” he wrote “could simply extend
economic imbalances, spelling possible trouble down the road.”
Big trouble. China
accounts for some 30% of global GDP growth, 12% of oil consumption
and about half the demand for steel, copper and cement.
“Will there be a
crisis?” asks Louis Kuijs, the Head of Asia Economics for the
research group Oxford Economics. “It depends how you define it.”
He sees a government bailout of the banks coming in a few years,
although he believes it will be manageable.
Rhetorically, at
least, President Xi Jinping acknowledges the exact dilemma that
spooks the rest of the world. If China falls back on excessive
stimulus, he was quoted recently as saying in the Communist Party’s
flagship journal, Qiushi, it will “create new contradictions and
problems.”
Yet he seems to
ignore his own advice. Two years ago, in a much-heralded effort to
address the problem of bad debt in the banking system, financial
authorities introduced a program to swap the bank borrowing of local
government-controlled entities—much of it linked to the slumping
real-estate sector—for municipal bonds. The arrangement should have
reduced the overall volume of bank loans. Instead, banks simply
filled the slack with new lending. In effect, the government had
created a whole new stream of credit.
One sure sign that
the debt problem is now out of control: Politicians have stopped
talking about it, except in the vaguest terms.
It hardly rated a
mention at the recent Economic Work Conference, the annual meeting of
China’s top economic mandarins.
Politics largely
explains the reluctance to face uncomfortable realities. Mr. Xi’s
own credibility is on the line. Upon taking office three years ago,
he promised a “great rejuvenation” of the Chinese nation. So
growth must stay robust; missed targets can’t be tolerated.
He’s chasing other
goals, too. By 2021, the centenary of the founding of the Communist
Party, China is supposed to have doubled per capita GDP from where it
was in 2010. And by 2049, the centenary of the founding of the
People’s Republic of China, state planners decree, China must be
among the world’s “moderately developed countries.”
Unfortunately for
Mr. Xi, the laws of gravity are immutable. Burdened by a debt problem
it can’t resolve, a China that’s been rising for decades will
come back down to earth.
Write to Andrew
Browne at andrew.browne@wsj.com
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