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Staring Down the Barrel: The Risks of China’s Unrestrained Credit May Be Coming to Bear

Updated: Nov 28, 2023

International Affairs Analyst

Xi Jinping | Credit: Government of Russia, Wikimedia Commons

History has shown the dangers of unrestrained credit. China’s desire for political control has allowed the CCP to forget these lessons.

In the last few decades, China's rapid economic growth has captured global attention, transforming the nation into an economic powerhouse. However, this ascent has been accompanied by a less visible but equally significant challenge: a mounting level of debt within the country's financial system. As China pursued a path of unprecedented industrialization, urbanization, and infrastructure development, its financial system expanded to fuel these ambitions. Consequently, China's high debt levels have garnered increasing concern both domestically and internationally, as questions arise about the potential consequences for the country's economic stability, global financial dynamics, and the overall sustainability of its growth trajectory. Recent reports of slowed Chinese economic growth could forecast a particularly dark future within China.

In order to understand the Chinese financial system, and how it differs from a Western model, it is worth understanding the roots of such a system, and the entire Asian financial model, to an extent. A brief history: Japan has historically had a unique view of debt and capital, in that money is meant not only to serve economic needs, but political needs as well. Such an attitude was encapsulated in the principle of tokusei, when if debt levels were ever mounting too high, the Emperor could simply absolve all debts. Of course, someone was always left holding the bag, but it was usually a group that was at odds with the Emperor anyways, so “nobody” was ever harmed. The point is not whether tokusei was ever an effective monetary policy, just that the Japanese were the first to view the financial system as a tool of the state. This attitude towards finance outright encouraged borrowing, and persisted until WWII, when the Allied powers granted the ultimate act of tokusei, for the not-so-small price of Hiroshima and Nagasaki, later welcoming Japan into the American-led free trade order.

Following the Japanese introduction into the Western community of nations, Japanese leadership found it absolutely imperative that post-WWII Japan prioritize political stability at all cost, an understandable goal given the sheer destruction and humiliation the Japanese had recently suffered. One key portion of this plan was to apply their particularly laid-back attitude towards debt towards the Japanese rebuilding effort, shoving massive amounts of credit towards literally any redevelopment project. While from a Western point of view, this would seem irresponsible at best, given that the lion’s share of these loans never had any real prospect at being paid back, it's worth remembering: the goal was to effectively purchase the loyalty and happiness of a population, gain maximum employment, thus achieving political stability. For a society as fractious and fragile as postwar Japan, they couldn’t be bothered by concerns as trivial as profit and efficiency. With this focus came rampant borrowing. Loans to start a new company, loans to hire a staff and purchase raw materials, loans to develop new products, loans to market those products to new consumers, loans for these consumers to purchase these new products. Can’t afford to pay back a loan? Take out another one.

This view spread to other Asian countries such as Korea, Taiwan, Hong Kong, and Singapore, all of which had once been Japanese colonies. Each country borrowed massively to support their transition into industrialized economies. Again, this isn’t to say that such an idea was without rationale. Western firms had increasingly been outsourcing their manufacturing to these East Asian nations, ensuring a captive market for Asian exports. Such demand was stable enough that these four countries were able, for the most part, to grow out of their debts they had incurred. Add in the creation of fiat currencies in 1971, and these countries, with Japan as the leader, all experimented with new and…innovative ways to push the limits of what was possible in the financial space.

As the most effusive adopters of the new fiat currency model, Japan became the most creative with how to navigate the new world of fiat currency. Many times, profits would not be enough to cover debt payments, so the Japanese would use export earnings to make payments. If that wasn’t enough, then Japan would simply expand their money supply, just to force payments forward. Ironically, being an export-oriented economy, the newly-devalued yen made Japanese exports even more competitive globally, which in turn would increase export earnings. In addition, many Asian firms made it difficult, both legally and culturally, for foreigners to gain access to their financial world, such as creating banks within their own corporate structures to finance their own projects.

However, nowhere else in the world has this debt-driven model of growth been adopted as enthusiastically, or as irresponsibly, as it has been in China. By the time the Chinese were ready to enter into the global economic scene in the 1980s, the U.S. dollar had been off the gold standard for a decade, meaning that the modern CCP has known nothing but fiat currencies and cheap money. Additionally, the Chinese government’s number 1 goal was national unity, even more so than the Japanese or Koreans. Japan and Korea are arguably the most ethnically “pure" states, with most financial and political centers being co-located. China, on the other hand is much different, being split into 3 main sections, with most political and military headquarters in the north, most economic activity concentrated along the Yangtze river in the center, and with the south being home to most minority groups and western-interfacing port cities, such as Macao, Hong Kong, and Guangzhou. All of this in a country larger than all of Western Europe, and with climates ranging from tundra to deserts to tropics, establishing national unity and achieving political stability is seen as paramount. In a world where finance could be used as a tool to achieve state goals, the CCP was more than happy to join this experiment.

The northern population centers sitting on the North China Plain, have traditionally considered to be the most culturally unified in China, as its incredibly flat nature have made it the most productive farmland within China, thus the traditional Chinese power center. However, this flat terrain has also made it incredibly vulnerable to outsiders, and has arguably been witness to more ethnic cleansings, wars and genocides than anywhere else on earth. As such, in order to defend against such violence, Chinese governments have, throughout history, placed a premium on achieving political stability. In other words, the political repression, state-sponsored violence, endless propaganda, and mass surveillance seen in modern-China is seen as absolutely necessary by the CCP in order to achieve this long sought-after political/social stability.

Another solution to avoid such future violence? Shove capital to everything. Loans for industrial buildouts, loans to build transport systems, capital for education, capital for literally anything that could remotely employ anyone. Like Japan, the goal was rarely about profit, or “wise capital allocation.” The Chinese have simply been using finance as a tool to achieve full employment, effectively purchasing the acquiescence of Chinese citizens, in order to avoid potential unrest.

According to Reuters, as of 2022, Chinese corporate debt has risen to over 350% of GDP, at around 385 trillion yuan, just under $60 trillion. China has also exploited the fiat model of currency, regularly printing the yuan at more than double the rate of the U.S. dollar, despite it not being used anywhere outside of China, save for a few Saudi oil imports. In essence, the Chinese economic system is one that is far more concerned with development rather than profit. If a project needs capital, the Chinese state is more than happy to provide endless amounts of credit, just to keep people working. If prices get too high, the CCP simply inflates the money supply.

Nearly every other country that has embraced this credit-driven economic model has been forced to come to terms with its inherent unsustainability. Japan’s economy crashed in 1989, and has resulted in three decades of stagnant growth. This crash also had the side-effect of gutting birth rates so thoroughly that Japan will struggle to have meaningful consumption-based economic growth again. Korea and Thailand both crashed in 1998, and were forced to reshape their governments, kind of. Even Western experiments with this credit-based model haven’t ended particularly well. The United States knows this as the Subprime Mortgage crisis in 2007-2009. Europeans know this as the entire country of Greece for the majority of the 2010s.

Greece in particular showcases the dangers of this model. Europe, being an extremely diverse continent both ethnically and culturally, has traditionally also had diverse and separate financial systems. Northern European countries like Germany, with its highly advanced and diversified economy and cultural penchant for being obsessively frugal and organized, enjoyed easy access to credit at extremely low interest rates. Interest rates in southern European countries tended to remain much higher, as Southern Europeans tended to be more laid back about making debt payments. However, with the 2001 introduction and widespread adoption of the Euro, every country within the EU gained access to credit at rates typically reserved for Germany.

Nearly every Southern European economy treated this newly accessible credit with the financial discipline of a teenager that just got their parent’s credit card, but Greece took it to new levels. Greek banks gave out massive loans for ultimately meaningless projects, such as building entirely new towns that nobody came to live in. Workers received bonuses for months that didn’t exist, and citizens received payments simply for being Greek citizens. In fact, the 2004 Athens Olympic Games was hosted and paid for, entirely on this new cheap credit.

Eventually, following the ‘07-’08 recession, the system eventually cracked. Greece, along with eight other EU member states were bailed out, primarily by Germany, but the Eurozone has not recovered. It wasn’t until 2018 that the Eurozone’s financial sector was able to even begin to enact a recovery plan, which got shoved back underwater in 2020 due to the global pandemic. Given Europe’s rapidly aging demographic, it's unlikely this debt will be paid off in the foreseeable future. As of 2023, Greece still remains in receivership, and its economy receives little more than tourism revenue.

The American’s credit experiment didn’t go much better. Starting in the 1950s, middle-class white Americans began conflating the “American Dream” with owning your own home. Eventually, backed by the combined forces of the U.S. government and Wall Street, firms were created that would identify prospective homebuyers, and provide them financing to purchase a home. These mortgages would then be packaged with hundreds more, then sold onto the U.S Bond market, with the idea being that these were the safest investments, as people would do whatever they possibly could to keep making their home payments. Additionally, as these were being sold as bonds, this meant that more investors could put their money in the market, increasing the supply of capital, thus making financing far cheaper. Eventually, these “Mortgage discovery” firms ran out of suitable prospects, and began financing people that had no realistic chance of truly making payments, hoping that they could sell their securities before people realized it. As expected, because purchasing a home takes a lot less time than building one, real estate prices rose exponentially, people began missing payments, and the entire system crashed, creating the 2007-09 Subprime Crisis.

Unfortunately for the Chinese, they have become far more dependent on unsustainable credit-driven growth than any other economy in human history, effectively attaching it to every economic sector within the Chinese system. Given that economic growth is the only source of legitimacy for CCP rule, every time they have tried to limit the amount of available credit, growth has slowed, and Chinese citizens have tended to ask uncomfortable questions about the ruling party. Or, they have simply found ways around the system. China now has a thriving “shadow banking” system, involving everything from loan sharks to fake life insurance policies in order to maintain credit flows.

While it would be unwise to assume that a month’s worth of poor economic data from within China are a sure sign of an armageddon-like financial meltdown, it is worth pointing out that the only way that the CCP can even hope to maintain such a system is with essentially bottomless foreign demand for Chinese goods. Such is no longer the case, especially following the 2020-21 COVID pandemic. China’s largest markets, the United States, Europe, South Korea, and Japan have become far more adversarial to Chinese interests, if not outright hostile. In addition, China’s breakneck urbanization, combined with 40 years of the 1-child policy have deeply aged Chinese demography, severely constraining China’s abilities to switch to a consumption-led economic model rather than its current investment/export-led. If the recent economic slowdowns continue for any meaningful period of time, China is staring down the barrel of a Greek-style financial collapse. Such a collapse would be far more disastrous, not just for the Chinese people, but would severely hinder several key industries, such as tech, automotive, and greentech manufacturing.


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