Since this spring, Beijing has canceled initial public offerings, fined tech companies billions for antitrust violations, forcibly shut down China’s entire for-profit education industry, and sent CEOs running for the exits to avoid the government’s ire. Even more dire, the Chinese megadeveloper Evergrande recently started missing payments on its more than $300 billion in debt, shaking global markets. The convulsions have woken the world up to a startling new possibility — that Beijing may be willing to allow some of its private corporate behemoths to collapse in a bid to reshape the economic model that made China a superpower.
The upheaval, spanning multiple industries and vast swaths of the country, is the result of one giant issue: China’s inability to borrow or buy its way out of its current economic crisis. For decades, the country relied on cheap labor and eye-popping amounts of debt, handed out by government-owned banks, to fuel economic growth — pouring money into massive apartment developments, factories, bridges, and other projects at lightning speed. Now the country needs people to actually use, and pay for, everything that’s been built. But the bulk of China’s population lacks the income needed to shift the economy from one driven by state investments to one sustained by consumer spending.
As a result, China finds itself stuck with a system that is overbuilt and overindebted. Take the country’s $52 trillion property market, of which the Evergrande mess is the poster child. With money easy to borrow, real-estate speculation became a popular way to store and build wealth for China’s young middle class. One academic described this model to me colorfully as an “addiction to real-estate cocaine.” It’s also been called a “treadmill to hell.”
And to make matters worse, China is also facing an energy crisis fueled by rising coal costs, as well as an aging working-age population without enough resources to retire.
In the face of all these obstacles, Beijing made a dubious decision. Instead of proceeding to open up the economy to stimulate expansion, the Chinese Communist Party is definitive. Under President Xi Jinping, Chinese socialism is returning to a style not noticed in decades, with a tighter state on much of the economy. That’s why we see Beijing canceling large IPOs and crushing entire industries. Economists expect this ideological shift to further slow expansion, making attempts to reshape China’s economy even more precarious.
“I think Xi is incredibly ideological, and he’s focused on his legacy,” Charlene Chu, a debt analyst at Autonomous Research, told me. “He really wants to reshape China and put it on the global stage — and that does require a reset from the way we’ve been doing things previously.”
The transition from open markets to the state will not be easy to manage and the stakes are high, for all of us. If Beijing fails to implement its ambitious plan, it could cause a shock wave that weakens the global monetary system, slows industry and devastates businesses around the world. The resulting chaos, and the resulting crisis of confidence in the CCP, may simply lead to social instability in China, leading the central government to exert even tighter control over civil society.
In short, Beijing is carrying out a big economic act, seeking to update its economic style with something unknown. In doing so, the weight of its old debt formula is causing China to falter. And if the country falls, it may take the rest of the world with it.
If you need to pinpoint the moment that put China on the path it is on today, go back to 1984. It was then that Deng Xiaoping, Chairman of the Communist Party, passed the Economic Structure Reform Decision, which rewrote the regulations of the Chinese economy. Instead of the state directly managing the commercial sector, it would now allow state-owned enterprises to thrive without direct government involvement.
This ideological flexibility – combined with the country’s creation of a fashionable banking formula – paved the way for the emergence of consistently independent companies. Freed from direct government oversight and reaping benefits from smooth borrowing, China’s productive sector has soared. Rural citizens flocked to fill the In 1992, 27 percent of the country’s population lived in urban areas. By 2020, that number had risen to 61%.
All this expansion accelerated in 2009, during the global currency crisis. To avoid a slowdown, the CCP ordered banks to extend larger loans to the entire economy, specifically to the real estate sector. But as the debt bubble grew, the new buildings remained empty. Despite a booming economy, many Chinese did not earn enough money for the homes they built or the goods they produced.
It was around 2011 when the world started to notice China’s jaw-dropping ghost cities and bridges to nowhere. Economists wondered when the debt bubble would pop, and there were several close calls. In 2015 it looked like China’s property market would collapse, along with the local governments that had helped finance them. But officials gave the sector a jolt by tearing down slums and relocating residents into new buildings.
The following year, Beijing began the procedure to gradually rid the system of debt. He allowed some corporations to default on their loans, ordered local governments to close surplus factories, and closed coal mines no longer needed to supply them with energy. But as excessive as those efforts were, they managed to make a dent in China’s debt bubble.
And that’s just one side of the equation. Without a constant churn of new manufacturing and construction jobs, there’s little hope left for hundreds of millions of Chinese citizens who left their villages to make money in the city. According to China’s National Bureau of Statistics, 600 million people have barely $2,700 to spend a year. With housing prices in major cities soaring, what President Xi refers to as “The Chinese Dream” — the idea that even the poorest in the country would take part in China’s rapid growth and modernization — is starting to look out of reach.
In an attempt to revive the Chinese dream, Xi promotes the concept that China is moving toward “unusual prosperity. ” But it’s hard to say precisely what that means. This may simply mean higher taxes on the high-income citizens who benefited the most from privatization: the generation of supertycoons who were allowed to “get rich first,” as Deng Xiaoping insisted. Or perhaps it is simply an attempt, outdated socialist rhetoric, to prepare citizens for more volatile times to come. But either way, it won’t make things better if Xi’s usual prosperity calendar proves detrimental to the country’s new middle class.
The truth is that China is returning to excessive state intervention, personal industry be damned. In the most striking example of state control, China eliminated its entire for-profit school sector in July, sending U. S. markets, where some companies were listed, into a tailspin.
“They took it to nearly zero in a matter of days,” Chu said. “It shows a willingness to tolerate a lot more volatility and pain than people expected.”
It is critical to note that one component of agitation is also about strength. By reaching out to China’s wealthiest citizens, Xi is building strength for himself and the CCP. Jack Ma, the billionaire founder of Alibaba, was once ubiquitous in Chinese society. But since the government began cracking down on his businesses, he has largely disappeared. The founder of ByteDance, the company that owns TikTok, also resigned as CEO, saying he liked “solitary activities. “Even online fan clubs of pop stars are regulated to inspire determination in the members. Last month, the former chairman of China’s largest alcohol maker was sentenced to life in prison for accepting bribes.
There is danger to this lack of power sharing and pluralism of opinions. Historically, the CCP has been a tug of war between openers and closers — those who want to welcome outside market forces and those who seek to restrict foreign access. But now the balance of power has shifted. Xi is a defiant closer, and his consolidation of power — including a lifetime appointment to the presidency — has left no pro-opening opposition to push for a course correction should things go awry.
And things will most likely go wrong. As Beijing attempts to shift its economy toward a new, more insular model, it will have to pick up the landmines left behind by the old one.
Take the example of Evergrande, which is now on the brink of default. Xi’s willingness to tolerate credit cuts imposed on big developers shows how determined he is to rebuild the economy. Last summer, to deflate the real estate sector, Beijing introduced new credit signs known as the 3 red lines. The promoters were required to have more money to be able to cover their debt if things went wrong. Evergrande could not increase the mandatory budget. . . and it is not the only one. Earlier this month, Fantasia Holdings, a luxury real estate developer, defaulted on a $206 million bond.
Investors around the world still don’t know when — or whether — the Chinese government will stop the bleeding. At the end of September, Chinese authorities met with the state-owned banks to let them know their role in all of this — above all else — would be to protect homeowners and keep the economy going, without resorting to their old debt-driven tricks.
“The nuanced message from officials is: ‘Don’t withdraw investment so that those complexes can’t be completed, but also don’t fund a competitive expansion of new developments,'” Chu told me. Once again, I’m walking a tightrope.
The real estate fiasco also means that Beijing will have to play a trust game on two fronts. Investors deserve to assume that the Chinese government can find a way to restructure maximum indebted assets of developers without causing a sudden drop in assets. sector, a task that will become more complicated as more developers show symptoms of stress. And consumers want to be sure that buying homes for money in the midst of a credit crisis is a smart decision, with the hope that home values will continue. “If confidence in pre-sales collapses, the game may be over,” Chu said. “That would immediately paralyze everything. ”
That, in turn, could trigger a plunge in real-estate values and send Chinese banks — and an entire world of investors holding their debt — careening into chaos.
This balance would be difficult to manage in all circumstances. But China’s sudden crisis of strength makes the task much more complicated. Electricity costs have more than doubled this year as pandemic-related lockdowns lifted and demands for goods soared. China’s coal reserves were already dwindling, thanks to the past wave of government mine closures, and Beijing made the situation worse by banning coal imports from Australia, pushing to investigate the origins of the coronavirus pandemic. Factories in 20 of China’s 31 provinces suffered a forced outage, and corporations including Tesla and Apple said the crisis would damage their supply chains. If Xi initiates a grab by force, it will be difficult to achieve it without force.
All of these not-growing pains would be easier to deal with if the world were in a cooperative mindset with China. But it’s not. Under Xi, China has become more bellicose on the world stage. It has encroached on democracy in Hong Kong, set up concentration camps for Uyghur Muslims in the Xinjiang province, intimidated its neighbors in the South China Sea, and menaced Taiwan as never before. In response, Western policymakers have dug in their heels. In May, the European Union torpedoed a trade deal with Beijing after China sanctioned members of the European Parliament for speaking out against human-rights abuses in Xinjiang.
US officials, upset that China isn’t purchasing nearly as many American goods as it promised to under a trade deal with the Trump administration, are also taking a hard line. Earlier this month, in a speech to the Center for Strategic and International Studies, US Trade Representative Katherine Tai made it clear Washington wanted Beijing to open its markets and respect the international rule of law.
“Above all, we will have to protect – until the end – our economic interests,” Tai said. This is not what the United States looks like when it gives another country a break.
But all this sword is unlikely to replace economic reality. China still has few options at the moment to curb its expansion, and China’s slow expansion will inevitably act as a drag on the global economy. As Joyce Chang, JPMorgan’s global head of research, put it, as noted at a recent conference, a one percentage point drop in Chinese expansion represents one percentage point of global expansion. Morgan Stanley estimates that from 2022 to 2025, China’s expansion will slow by 0. 4 percentage points each year more than estimated in the past, and that’s the best-case scenario. If investment contracts sharply, China’s expansion could fall by 1. 2 percentage points each year, depressing global economies.
China’s slowdown will most directly affect its closest Asian neighbors (South Korea and Taiwan), as well as energy and raw fabric suppliers such as Russia and Norway. And the entire world will feel the weight of China’s weakness through slower and more costly exports. , the economic repercussions will almost in fact be accompanied by social unrest. Stanford economist Scott Rozelle fears that Beijing will respond to any risk to its authority by exacerbating nationalist sentiment.
From its inception, the modern Chinese economy has been full of contradictions. It combined socialist management with a dynamic private sector. It created a massive debt bubble that failed to pop. Throughout all this economic modernization and social transformation, speedy growth kept Chinese society stable. But if Xi’s attempts to sort out China’s economic discrepancies cause that growth to evaporate, social stability could well vanish along with it. If that happens, we risk more than the collapse of the global economic order; we risk the shattering of global peace as well.
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