Economists wondering where China’s economy is heading have a Lehman Brothers problem on their hands.
Too often, analyses on the more than $9 trillion of debt that state banks and other creditors are owed by China’s local government investment arms are framed around a 2008-like crisis. Blame it on breathless speculation about the “Lehman moment” many believe is sure to devastate Asia’s biggest economy.
It’s not the most irrational of ideas, of course. Arguably, no rising power driven by debt-fueled economic growth has avoided a so-called “Minsky’s moment.” China’s odds of steering clear of the kind of reckoning that felled Japan, Southeast Asia and Wall Street aren’t great.
To be sure, China’s off-balance credit boom via local government financing vehicles (LGFVs) is a threat to an already opaque and lopsided economy. We’re talking about a debt pile bigger than the combined gross domestic product of Japan, Germany and Finland.
One could argue that a better frame of reference is the national equivalent of Enron Corp., which blew up in 2001. Either by design or chance, the prevalence of special purpose entities has helped China’s Communist Party obscure mountains of debt and toxic assets. It leaves global credit rating agencies not knowing what they don’t know about China Inc.
Masking the cracks has become harder in the two years since giant developer China Evergrande Group defaulted. And harder still as Country Garden’s will-it-or-won’t-it default drama dominates global headlines. Troubles at Zhongzhi Enterprise Group are fueling concerns about the shadow banking sector’s ability to weather slowing growth.
Yet for 25 years now, no giant economy has so consistently confounded the naysayers predicting a crash. Whether your reference point is Enron, Lehman or the reckonings of which economist Hyman Minsky warned, China has time and time again steered away from the cliff.
Is Chinese leader Xi Jinping’s luck running out? It certainly is in one sense as the nation’s troubles greatly lower the odds it can get economic growth back into the 5%-plus range.
For an economy of China’s scale and level of development, 2022’s 3% growth rate was recessionary territory. And it was largely a self-imposed downshift resulting from Xi’s draconian Covid-19 lockdowns.
Once China reopened, growth didn’t snap back, as universally expected. Explanations include: traumatized consumers saving more post-pandemic than spending; headwinds from a cratering property sector overwhelmed reopening tailwinds; inflation from Russia’s Ukraine invasion devastating the export scene; collateral damage from U.S. President Joe Biden’s curbs on China’s access to vital technology.
The common thread is a realization that a Chinese model that worked so well for three decades is facing an existential crisis. Even if China doesn’t plunge into a crisis that shakes the globe, the rapid growth needed to surpass the U.S. economy by 2030 or 2040 seem over.
This is surely a crisis moment for Xi’s party, whose legitimacy hinges on growth well north of 5%. And since China doesn’t exactly do—or allow—broad-based polling, it’s impossible to know how the nation’s 1.4 billion or the 500 party bigwigs at the top of the food chain regard Xi’s performance.
The real challenge for Xi is knowing which economic fire to address first. The property sector, which can generate 30% of GDP, is one speed bump. The depth of the problem echoes the 1990s bad-loan crisis that’s still weighing in Japan today.
Look no further than the Bank of Japan, which has remained trapped in the quantitative easing zone for 24 years now. Any hint that BOJ Governor Kazuo Ueda might one day throttle back on QE risks pushing Japan back into deflation and slamming global markets.
Xi did his economy no favors by clamping down on the tech sector. Starting with Alibaba Group founder Jack Ma in late 2020, Xi’s regulators let China’s most famous innovators know who’s boss. In less than a year, the stunt erased more than $1 trillion of tech stock wealth.
Another problem is that China’s stimulus machine is losing power. Simply put, China has resorted to massive infrastructure booms too many times over the last 30 years. Like a medicine or steroid, the response is no longer sufficient to stabilize the patient this time. China’s debt, including LGFVs, is becoming a global headwind, too.
Demographic strains are also coming to a head. As China ages, the deflationary forces spooking the population risk becoming more ingrained. Xi’s party, meantime, has been too slow to build bigger social safety nets to encourage households to spend more and save less.
All these forces are coming together to make 2023 a year Xi’s inner circle must be hating. And essentially taking China out of the game of driving global growth in the year ahead.
This period of underperformance that China is navigating comes as Japanese growth slows and Europe walks in place. Though the U.S. may avoid recession, the biggest economy is suffering the effects of 17 months of Federal Reserve tightening.
So crash or not, China’s downshift into moderate growth territory is unwelcome news both for Xi’s standing in Beijing and the global economy.