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That’s what is happening in China today. Everywhere you look, the signs of rot are apparent. In a mad-cap quest to dominate green energy, China’s banks pumped billions into solar-panel manufacturing, creating hundreds of factories and vaulting China into the world’s largest producer. Now the sector has become a victim of its own excess: companies are failing, symbolized by the recent bankruptcy of market leader Suntech Power. Steel companies continue to invest in new capacity even though debt is rising and losses mounting. Each mill is backed by local officials eager to create jobs but dismissive of the larger costs. The investments top up GDP, but not the health of the overall economy. Inefficient, subsidized state-owned enterprises gobble up credit while more nimble private firms starve. The froth on China’s booming property market defies government efforts to calm it down. Facing meager investment options in China’s controlled financial markets, couples are choosing divorce to sidestep restrictions and taxes on apartments deals. Most frightening, debt has risen precipitously. Rating agency Fitch says credit relative to GDP reached 198% at the end of 2012, a startling increase from 125% in 2008. Local government debt has escalated in recent years, to an estimated $2 trillion, or 25% of GDP. The risks have been heightened by the emergence of “shadow banking” — mysterious, unconventional sources of lending often kept off the banks’ balance sheets — which George Soros recently warned could be as risky as the toxic subprime-mortgage securities that tanked Wall Street.
Where is this all headed? “Panda huggers” (the optimists) believe that China’s leadership is tackling these problems and there is no threat to economic stability. “Dragon slayers” (the pessimists) warn that similar surges of debt have toppled other economies into financial crises. Everyone, however, agrees the current situation can’t last. The economy requires more and more debt to produce the same amount of output. In order for China to keep its current growth model running, therefore, debt levels must continue to rise — to ever more dangerous levels.
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There is also consensus on the solution. Economists have been warning for years that China must decrease its dependence on investment for growth and “rebalance” to allow consumption to play a bigger role. Government officials point out signs of progress — first-quarter GDP was driven upward more by consumption than investment, for instance. But progress is, at best, at a crawl. Private consumption relative to GDP in China is still the lowest among major economies. The government has simply balked at the reforms necessary to change that. Feeble health care and pension systems force households to save; then controls on interest rates keep returns on bank deposits meager, punishing them for saving. If anything, much government policy has reinforced China’s old growth model — including the heralded state-heavy stimulus program launched after the 2008 financial crisis. Businessmen in China speak of a “lost decade” of stalled reform.
Even if China reforms more quickly, the economy is likely to slow as it transitions to more consumption-heavy growth. But if China drags its feet on reform, growth will likely be slower anyway, as its old model sputters and creaks. That means that under just about every scenario, the world can’t count on a supercharged China to hold up global growth while the U.S. and Europe remain mired in debt and joblessness. But a slower China may actually be a good thing. A reformed, rebalanced Chinese economy will be a less risky, more stable force in the global economy. The much bigger risk comes from a China that doesn’t discard its failing growth model. That could push China into a financial crisis. Now that’s really something to worry about.
Sources:Times