China’s Looming Debt Disaster
In the aftermath of Washington’s debt-ceiling debacle, Vice President Joe Biden was in Beijing on Friday, desperately trying to reassure the Chinese government that the American economy is not in a downward spiral.
“And very sincerely, I want to make clear that you have nothing to worry about,” the vice president said.
Whether or not he succeeded in soothing his hosts’ anxiety remains to be seen. Yet in trying to placate Beijing, the vice president was making a major miscalculation. China may own $1.2 trillion in U.S. Treasury obligations, but from the get-go, Biden should have eschewed playing defense and gone on the offensive. He should have asked the Chinese to reassure him about their debt problems and, more urgently, their impending economic slide.
Despite all the apocalyptic pronouncements about America’s budget problems, the reality is that the U.S. has a higher credit rating than China and, unlike Beijing, has never repudiated its sovereign debt. More important, the People’s Republic has been understating its debt for years to avoid global attention and criticism.
Indeed, China claims its debt-to-GDP ratio—the standard measure of sustainability—was a healthy 17 percent at the end of last year. Yet Beijing-based Dragonomics, a well-respected consultancy, put China’s ratio at 89 percent—about the same as America’s. Worse still, a growing number of analysts think the Chinese ratio was really 160 percent. At that astronomical level, China looks worse than Greece.
The wide discrepancy in estimates is due to the so-called hidden debts. The largest of these off-the-books obligations have been incurred by local governments and state banks. Yet there are other components, including central-government debt incurred for municipal and local projects, Ministry of Finance guarantees related to partial bank recapitalizations, and miscellaneous obligations such as grain-subsidy payments. No one actually thinks Beijing will default on its outstanding external debt, but these hidden obligations matter; to work down the crushing debt load, the country’s technocrats are adopting strategies that will cripple growth for a decade, maybe longer.
It didn’t have to happen this way. When the global downturn hit in 2008, China decided to spend its way out of the crisis. The country adopted a stimulus program that in 2009 pumped, according to my calculations, about $1.1 trillion into its then–$4.3 trillion economy. Beijing created robust growth—9.1 percent in 2009 and 10.3 percent last year—but in the process, the country’s hidden debts ballooned, as the country’s leaders forced state banks to lend to unviable projects.
These include ghost cities such as Ordos in Inner Mongolia, where the government has built sundry new homes and office buildings, which remain empty. Last year, the state grid reported there were 64.5 million flats—enough housing for 200 million people—that used no electricity for six consecutive months. Despite the obvious oversupply, the government—in conjunction with private developers—is constructing 40 million to 50 million more units. And the Chinese government recently announced it will be building 20 new cities a year over the next two decades.
All this building is technically creating gross domestic product, but it is extraordinarily wasteful. In a free-market economy, this grossly imbalanced situation would lead to both a property crisis and a banking crisis. Weak developers and financial institutions would go bankrupt, their assets would end up in the hands of more productive market participants, and the economy would recover quickly.
But Chinese leaders are not allowing this creative destruction to occur. To rescue financial institutions, for instance, central authorities are forcing down interest rates paid to depositors so that banks can earn their way out of difficulties. Yet in doing so, they are condemning their economy to years of stagnation.
By keeping deposit rates artificially low, the government depresses the income of households. Consumption accounts for just 34 percent of the economy in China—the lowest rate in the world—compared with about 70 percent in America. For the country’s economy to achieve sustainability, its consumers will have to spend more.
That’s unlikely to happen, however, as Beijing is essentially adopting the same fundamentally flawed tactic that Tokyo employed in the early 1990s to work its way out of its infamous housing bubble. Japan’s economy has never fully regained its dynamism, and China’s won’t either, unless Beijing radically changes course.
Politically, that doesn’t seem feasible. The Communist Party has begun its historic transition from fourth- to fifth-generation leaders, and the result has been paralysis. At the moment, current officials seem to be just buying time until they leave office—and then hand intractable problems to someone else. No one in Beijing is willing to take the steps necessary to put the economy on a sound basis.
Washington, of course, is no stranger to gridlock and head-in-the-sand economics. Yet until now, just about everyone seemed to be looking to the Chinese to become the new engine of world economic growth. We will surely be disappointed. China has just begun another long descent. Biden should have spoken up.