Forget trade war. China already in crisis with bankrupt firms, gutted banks

Car sales fell last year in China for the first time in more than two decades

Once again, the world’s investors are turning their worried gaze toward China. And for good reason. Economic growth in the third quarter sank to 6.5 per cent, the slowest pace since the depths of the global financial crisis in 2009. Car purchases fell last year for the first time in more than two decades. Apple’s warning in early January that iPhone sales in China were sagging alerted the world to how a slowing Middle Kingdom would drag down global growth and corporate profits. But the locals figured that out a while ago. Even after a recent uptick, the stock market in Shanghai has still plunged by more than a quarter from its 2018 high. The outlook isn’t any rosier. Tariffs on Chinese exports to the US imposed by President Donald Trump are starting to pinch the country’s factories. A steep and unexpected plunge in imports in December signaled just how sharply the economy is decelerating. That’s led Beijing to turn the volume down on its bravado and negotiate with Washington to defuse the conflict.

 
A trade pact, if it happens, may soothe investors, and perhaps even juice economic growth—at least temporarily. But it won’t bring an end to China’s woes. While tariffs are a nuisance, the real problems run deeper, embedded in China’s financial structure.
 
What goes widely unnoticed is that China is already in crisis. No, it’s not the sort of hold-on-for-dear-life collapse the US had in 2008 or the surprising, ferocious meltdowns the Asian Tiger economies experienced in 1997. Nonetheless, it’s a crisis, complete with gutted banks, bankrupt companies, and state bailouts. Since the Chinese distinguish their model of state capitalism as “socialism with Chinese characteristics,” let’s call this a “financial crisis with Chinese attributes.”

 

This crisis is not merely about the current slowdown in growth. It’s been going on for a while, and by the looks of it, isn’t going away anytime soon. On the surface, the whole idea that China is in a crisis may sound ridiculous. Growth has tapered off, but it remains relatively strong—assuming you believe the government’s figures. Banks  aren’t tumbling into insolvency on a massive scale. While anxiety over the state of the economy has mounted—thus the pullback by Chinese shoppers—the mood in China hasn’t degenerated into the gloom that usually accompanies financial upheavals. True, China may never suffer the panicked fiasco that emanated from Wall Street in 2008. This financial crisis isn’t taking the same course as most others. Rather than a sudden explosion that destroys banks and jobs, China’s version is protracted, moving so slowly that it can be hard to notice.

 
A few years ago, some China watchers predicted the economy could tumble into a 2008-like collapse. All the warning signs for catastrophe were flashing bright red: a housing bubble, excess capacity in industries from steel to solar panels, and most worrisome of all, a debt buildup of gargantuan proportions. Total debt relative to national output surged to 253 percent in mid-2018, from only 140 percent a decade earlier, according to the Bank for International Settlements. No emerging economy since the 1990s has had such an outsize debt expansion and escaped some sort of financial calamity. China would have to defy history to dodge a debt disaster.

 
We’ve been watching and waiting for China’s Lehman Brothers moment—then waiting some more. It never arrived. Some analysts have come to figure it never will—that, indeed, China is too big to fail. The Chinese government, the new argument goes, has so many levers of control—over banks, big corporations, and capital flows—that it can suppress the sort of crisis a more liberal economy can’t prevent. This superpower was on display in 2015 after a stock market bubble burst, fuelled by shifty lending and bureaucratic ineptitude. Money flooded out of the country as the currency staggered. What would likely have laid other emerging markets low was just another day’s work for China’s powerful mandarins. The government organised a stock bailout and clamped down on capital outflows. Crisis averted.That approach is representative of Beijing’s overall strategy toward its debt problem. The government—obsessed with social stability—isn’t allowing the debt bomb to detonate. Lehman moments might be terrifying, but they’re also cleansing, an opportunity for the market to scrub out the bad stuff and clear room for new. Beijing, by stopping that from happening, is allowing the waste to rot and fester, likely enlarging the costs of the unavoidable cleanup.