ACCORDING to a report by Zero Hedge over the weekend, the Chinese economy is again on the point of collapse, thanks in large part to its steel industry’s drowning in debt and oversupply.
The argument, which on its face is backed by evidence and admittedly compelling, goes something like this: Between 2007 and the present, China’s debt has ballooned from about $7.4 trillion to nearly $30 trillion, roughly doubling its consolidated debt to GDP ratio from 158 percent to 300 percent.
This enormous, rapid expansion of credit was encouraged not only by China’s leadership, but tacitly enabled by the rest of the world as well. From the Chinese point of view, allowing it served as a form of stimulus to keep up growth momentum through the global economic turmoil of 2008-2009, and from the point of view of the rest of the world, the Chinese appetite for commodities kept the global downturn from becoming a rout.
Eventually, however, China drove its economy to a saturation point—one that is most visibly apparent in the existence of dozens of “ghost cities” around the country.
Because the Chinese expansion was driven more by the availability of cheap money rather than sustainable demand (i.e., the apparent high demand would not have existed in the first place in the absence of available credit), when the money ran out, demand collapsed. Zero Hedge places this point sometime in the latter half of last year, when China’s enormous “shadow banking” sector suddenly stopped lending and began to go into reverse. And this, of course, left many sectors—the Chinese steel industry in particular—leveraged far beyond the amount they could ever hope to clear.
How bad is it? Since the downturn in demand depressed commodity prices (which, of course, have the follow-on effect of depressing prices of finished goods), “over half the debtors in China’s commodity space are generating so little cash, they can’t even cover their interest payments,” Zero Hedge reports. As one example, Sinosteel, a state-owned company, virtually went into default in the middle of last month when one of its subsidiaries reported (on the day before the maturation date of the securities in question) that it did not have the funds to cover RMB 2 billion ($315 million) in five-year bonds sold in 2010.
The apparent solution to that problem—no one knows for certain if this is what happened or not, and the Chinese aren’t talking—was a quick, discreet government bailout. The assumption is, that was indeed what transpired, because both the formal and “shadow” financing sources, the only other possible sources of rescue, are not lending to industries that are, for all practical purposes, currently insolvent, or at least not lending at interest rates companies can bear. The Chinese government has no choice but to intervene, because a large-scale bankruptcy would have a terrible ripple effect across financial markets, and push even more companies over the edge.
All of that sounds logical, all of it is supported by extensive data from reliable sources, but there is one glaring problem with it: China’s actual performance, as the real-world record since the global financial crisis shows, has agreed with predictions of its failure precisely zero times.
Over the past five years, entire legions of business writers and analysts have made predicting the collapse of the Chinese economy a full-time job, yet China has remained stubbornly uncooperative. Overall, its economy has slowed—the Chinese leadership itself frankly admits that—but it is still growing at a pace that puts the rest of the world in deep shade.
There are a couple things happening that we need to understand if we are to have any hope of actually understanding and being able to make useful forecasts about the Chinese economy. What is probably the most obvious is a distinct western bias in media and analysts’ perspectives. A large part of that bias is political; China, despite its scale (or perhaps because of it), is still very much an interloper on the global stage, and those of us who are not a part of its sphere see indicators of failure because we want to see them.
China is also unique; we tend to forget that its economic model has no historical precedent, and is really only about 25 years old. As an entity, it does not respond in the way many conventional economic principles say it should, and that is both confusing and a little frightening.
With respect to that realization, the optimistic conclusion would be that we still have a lot to learn from China about the ways an economy can actually work, and that if we put just a bit more effort into being objective, we may very well learn that our sense of alarm is largely unjustified. A more pessimistic outlook would be that, given the inevitability that all economies will experience cycles of growth and retreat, China’s unconventional model will lead to a novel crisis we do not have the capacity to anticipate.