Crisis symptoms are emerging in China: Real estate bubble, debt, deflation, demographics, U.S. sanctions, investor flight, loss of confidence in the CP, etc. Companies like Country Garden face massive liquidity pressure and China Evergrande filed to bankruptcy protection in the United States. For a country that has long prided itself on implementing proactive policies to pre-empt economic pressures, the latest stimulus measures of the state are quite reactive. Non-financial debt stood at 297 per cent of GDP at the end of 2022. That is more than double the ratio at the onset of the global financial crisis in late 2008, when it was 139 per cent. Maybe Chinese economy cannot afford another round of debt-financed stimulus. Also the new consumer plan makes not so much hope. Growth in corporate debt accounted in the last years for 47 per cent of the total increase in China’s indebtedness, the share of government debt was 30 per cent and household debt made up the remaining 23 per cent. We saw an increased leverage of debt-intensive, low-return state-owned enterprises and a higher concentration of public indebtedness in local govenment areas. If China’s growth rate slows to 3 to 4 per cent its contribution to global growth will be halved, with obvious effects for the rest of the world.
The Chinese model is based on a complex of state-private enterprises in which private capital accounts for a large share of urban employment. The state plays a key role in the financial system, in regulating private capital, in massive public spending, especially on infrastructure, and in planning. This may be a different model of capitalist development than the Western neoliberal variety, but it still obeys the laws of capital accumulation. After opening up to global capitalism in the 1980s, China became a market for transnational corporations and a repository for surplus accumulated capital that could benefit from a huge supply of cheap labor controlled by a repressive, pervasive surveillance state.
In China, since the 1980s, a form of state-controlled enterprise has emerged characterized by a hybridization of private and state ownership structures and governance processes. This means that the Chinese state, which by all means encompasses various groups, remains a central actor in domestic and foreign economic processes, and thus the economy integrates the state to a special degree in its orientation toward long-term positive capital accumulation. A partly private-sector accumulation of capital, but especially the state organization and control of the Chinese financial sector, were an important condition for the industrialization processes and the technological upgrading of the Chinese economy. In addition, factors such as the influx of Western capital, the development of large enterprises and access to the world market contributed to the establishment of an export-oriented industrialization and accumulation regime in the course of the market-economy reform processes initiated by the state. However, important sectors remained the property of national capital and are managed by private and state enterprises. Today, the privately organized tech sector plays an increasingly important role.
Nevertheless, the highly financialized Chinese economy and the Chinese banking sector in particular are largely under state control. Particularly since 2017, the state and China’s CCP have subjected the financial sector to institutional reorganization, transferring operational management from state agencies to the CCP Central Committee. The largest financial institutions-commercial banks, investment banks, insurance companies, or asset managers-are controlled by the state. According to Forbes Magazine’s Global 2000 rankings, the Industrial and Commercial Bank of China (ICBC), a Chinese state-owned bank, is now the largest listed company in the world. In fifth place is only Wall Street-owned JPMorgan Chase.
The nominal concentration of power does not preclude organizational fragmentation, organizational fragmentation, and occasionally even some disorder. Major rivalries play out among the public institutions themselves, both horizontally (between the central bank and regulators) and vertically (between the State Council and provincial governments). China’s financial industry is an important battleground for the most powerful political and economic actors seeking to profit from their control over state assets. The financial industry can therefore be treated as an integral part of the political system.
China’s booming export sector has accumulated huge amounts of foreign reserves since the mid-1990s. In China’s closed financial system, exporters are forced to exchange their foreign earnings through the central bank, which creates a corresponding RMB to absorb the foreign currencies. This led to a rapid expansion of RMB liquidity in the economy. At the same time, the credit system grew. Because the banking system is controlled by the party-state, including state-owned or state-affiliated enterprises, the state-owned sector enjoyed privileged access to government bank credit, through which an investment boom was triggered. The result was rising employment, an economic boom, and a windfall for the elite. But this dynamic also left behind superfluous and unprofitable construction projects: empty apartments, unused airports, redundant coal-fired power plants and steel mills. That, in turn, led to falling profits, slowing growth and mounting debt in key sectors of the economy.
Throughout the 2010s, the party-state periodically extended new loans to stem the downturn. To help offset the effects of the crisis, policymakers announced a massive stimulus program that included 4 trillion Renminbi in spending, focused primarily on infrastructure. Of the 4 trillion RMB in announced spending, the central government committed to financing only 1.22 trillion – just 30%. The remainder fell upon local governments, banks, and state-owned enterprises (SOEs). Financial regulatory standards were also loosened, as the government pressured banks to lend freely. This move led to a massive increase in debt, with the total stock of credit in the Chinese economy more than doubling between the end of 2008 and the end of 2011. Many companies took advantage of the cheap bank loans to refinance their existing debt without making new expenditures or investments. Over time, the economy lost momentum as zombie companies were kept alive by debt alone: a classic case of the ‘balance sheet recession’ that hit Japan after the boom ended in the early 1990s. The illusion of limitless high-speed growth prevailed just as the economy was entering its worst crisis since the beginning of the market reform era.
But many companies took advantage of the cheap bank loans to refinance their existing debt without making new expenditures or investments. Over time, the economy lost momentum as zombie companies were kept alive by debt alone: a classic case of the ‘balance sheet recession’ that hit Japan after the boom ended in the early 1990s. The illusion of limitless high-speed growth prevailed just as the economy was entering its worst crisis since the beginning of the market reform era.
At the same time, here’s what happened: In the first two decades of the 21st century, China was among the world leaders of a wave of foreign direct investment in countries of the global South and North, deepening the transnational integration of capital and accelerating capitalist transformation in the countries where it invests. Between 1991 and 2003, China’s foreign direct investment increased 10-fold and then 13.7-fold from 2004 to 2013, from $45 billion to $613 billion. By 2015, China had become the world’s third largest foreign investor. Its outward FDI began to exceed inward FDI, and the country became a net creditor.
An obvious step beyond international capital expansion to alleviate the crisis and over-accumulation would be redistributive reform to boost household income and thus household consumption. Since the late 1990s, there have been calls to reorient the Chinese economy in favor of a more sustainable growth model by reducing reliance on exports and fixed investment such as infrastructure construction. This led to some reform-oriented, redistributive measures under the 2003-13 governments of Hu Jintao and Wen Jiabao, such as the new Labor Contract Law, the abolition of the agricultural tax, and the redirection of state investment to rural inland regions. But the weight of vested interests (state-owned enterprises as well as local governments that benefit from construction contracts and state bank loans that finance these projects) and the powerlessness of the social groups that could benefit from such restructuring policies (workers, peasants, and middle-class households) have prevented reformism from taking root. More recently, Xi has made clear that his ‘common prosperity program’ is neither a return to Mao-era egalitarianism nor a production of a welfare state. Rather, it is about reasserting the state’s role vis-à-vis capital, increasing its presence in the technology and real estate sectors, and aligning private enterprises with the nation’s broader interests. In official political speeches, ‘security’ has become the most frequently mentioned word, pushing ‘economy’ into the background. This explains the abolition of presidential term limits in 2018, the centralization of power in Xi’s hands, the relentless campaign to root out party factions in the name of fighting corruption, the construction of a growing surveillance state, and the shift in the state’s basis of legitimacy The current weakening of the economy and the entrenchment of authoritarianism are not easily reversible trends.
Looking a bit closer at China’s economy in connection with its financial system, one has to analyze the process of crisis credit deterioration over the years. In China, GDP is an input that is politically determined at the beginning of a period. Once China announces its GDP target, local authorities are responsible for deploying enough economic activity to close the gap between the GDP growth target and what is called and measured as high-quality growth (the private sector growth rate, which consists of consumption, exports, and business investment). Bridging the gap between the two had not been a problem for the Chinese economy since the 1980s, mainly because China had a significant investment backlog in real estate, infrastructure, and production capacity, so most of the investment required to meet the GDP growth target had to be considered productive.
This began to change ten to fifteen years ago, when China largely closed the gap between existing investment and the investment that the economy could productively absorb. When this happened, China should have drastically reduced the share of reinvestment in output, but to do this without causing a drastic decline in economic growth would have required shifting the economy toward more consumption, which in turn meant transferring income from previously successful parts of the economy to the household sector. However, China found itself politically and institutionally unable to manage this transfer comprehensively. Instead, it continued to keep investment growth rates high, and systematically began to overinvest in projects that did not so much increase the profitability of the economy as lead to higher costs. The result was a dramatic increase in the country’s debt burden. When debt is used to finance unproductive investment, debt increases faster than a country’s debt servicing capacity, of which GDP is an indicator.
The Chinese financial system is completely dominated by banks, and lending decisions are determined administratively and politically, largely through various forms of governance by the People’s Bank of China, the State Council, and local governments. The rise in debt has been reflected either on banks’ balance sheets or in bank-supported enterprises. While the increase in debt on banks’ balance sheets was accompanied by an increase in the book value of assets, the actual economic value of those assets was often far below book value, so that seemingly healthy balance sheets were in fact often heavily burdened and contained hidden losses.
All of these problems were exacerbated by developments in China’s real estate sector, which is a mirror image of overall infrastructure spending. The real estate sector absorbed a significant portion (about 25 to 30 percent) of China’s high investment rate over extended periods (investment accounts for about 40 to 45 percent of China’s GDP). Thus, the real estate sector has been an important engine that has enabled Beijing to achieve its growth targets, but it required enormous debt that quickly outstripped the value of the associated projects, and this arrangement depended for many years on an implicit guarantee (in this case, from steadily rising real estate prices) that gave developers free rein to leverage.
In addition, the stresses on China’s banking system were exacerbated by the way households, companies and financial institutions systematically took on too much financial risk on their balance sheets. Typically, companies that take too little risk underperform and are eventually forced out of the market, while companies that take too much risk initially do better but then run into trouble when corrections occur. A problem occurs when an economy, as in China, has many years of rapid growth, increasing liquidity, and rising real estate and asset prices. Under such circumstances, the very companies that tend to take too much risk are hardly disciplined and systematically perform better than companies that take a more prudent level of risk. In such a system, as Hyman Minsky already knew, over time all households, firms and banks are forced to take similar risks if they do not want to fall behind their competitors.
So at the individual level, households and firms take on excessive debt but do not adjust their balance sheets. At the same time, systemic risk unfolds insofar as there is a close correlation between the debt of private households and that of firms, all of which incur excessive debt and unbalance their balance sheets in a similar dynamic. This is similar to the treadmill effect as described by LiPuma. (LiPuma 2016) Bankruptcies and balance sheet collapses do not occur singly and randomly, but in coordinated waves among a large number of firms simultaneously. When forms of excessive risk-taking are highly correlated across a large number and variety of firms, this leads to an increase in systemic risk, i.e., the risk of a collapse of the entire financial system. For this reason, Minsky considered the correlation between the balance sheets of the overall economy and the financial system to be more important than the risk of individual balance sheets.
Households and firms adapt their strategies to their operating environment so that conditions or distortions that have characterized the economy for many years are integrated into the operations of these actors. In parallel, financial conditions that have been sustained for many years become embedded in the balance sheets of households and firms. After many years of stable or improving exchange rates, consistent monetary policy, falling inflation, rising asset prices, and increasing liquidity, financial institutions begin to structure increasingly risky financial activities that implicitly or explicitly assume these risks. Finally, if asset prices rise faster than underlying economic growth, this may even have a procyclical effect on the economy.
As real estate prices had been rising steadily in China, even companies that overinvested in real estate relative to their operating needs outperformed and eventually crowded out those that did not, while banks that directly or indirectly lent on real estate tolerated excessively risky loans on the assumption that their risks would be mitigated by steadily rising real estate prices. Thus, as China became more urbanized and the productivity of its enterprises grew, real estate prices began to rise. As long as property prices reflect the fundamental demand for current use, rising property prices serve an important economic function. In China’s case, however, rising real estate prices year after year have changed the behavior of enterprises in ways that have led to price distortions. After a period of rising prices, companies with higher risk appetites and more optimistic outlooks will eventually begin to anticipate their future real estate needs. Assuming that real estate prices will continue to rise indefinitely, they buy more land than they need operationally, speculating on future price increases. In such circumstances, the most successful companies are often not those that most successfully manufacture and market products, but those that speculate most aggressively on real estate. As real estate prices continue to rise, firms willing to take excessive real estate risk consistently outperform their more cautious competitors, and over time the former begin to displace the latter. Over time, real estate purchases move from a largely fundamental approach based on the company’s operating needs at the time of purchase to one that is at least partially and eventually largely speculative. This gradual and procyclical transformation of the market likely began in China in the 1990s, with the surge in demand triggered by speculative buying causing prices to rise faster than they otherwise would have, thereby undercutting the economic function of prices in the efficient allocation of land. Instead of favoring the most productive land users, the price mechanism began to favor speculators.
Real estate prices can rise rapidly over a period of years, and since the conflation of speculative gains and operating profits cannot be easily resolved, speculative gains inevitably begin to act as a higher value-added component of GDP growth, as wealth effects drive spending on real estate even higher. Even GDP growth is further boosted over time by rising real estate prices and speculative real estate developments, which in turn are boosted by high GDP growth expectations, with each element reinforcing the other. There are other examples of this type of speculative fnancialization: when the central bank guarantees liquidity and lowers interest rates, the cost of maintaining high inventory levels falls, and firms adjust by maintaining production levels regardless of demand trends. When firms anticipate a stable and undervalued currency, export sectors effectively bet on currency stability and exports increase relative to imports and domestic demand. Under these circumstances, firms are rewarded for individual behavior, but that behavior makes the system as a whole riskier, and they are punished with consistently poor performance relative to their peers if they do not engage in that behavior.
The implied value of liquidity increases as a growing share of economic balances are adjusted in this way, so that any degree of mismatch becomes increasingly risky. If more and more financial firms must eventually tighten liquidity by taking on illiquid balance sheet items, they will reduce liquidity in the operating part of the economy. The problem of liquidity is now notoriously understated. Therefore, the consequences of a liquidity shock, which must eventually occur, can be unexpected. As households, firms, and financial institutions then rush to convert their risky assets into cash and other liquid instruments, the price of risky assets falls and the value of liquidity rises. When this happens, firms can enter a bottleneck in which asset prices and earnings fall while the cost of funding rises-until the central bank is forced to step in to address the liquidity imbalances in the economy.
Long periods of rapid growth are associated, witness the developments in China just now, with a kind of financial frenzy that almost always leads to overvalued asset prices and, usually, higher real estate prices. But if this escalating positive trend reverses and the overvalued asset prices are corrected, businesses and homeowners face a decline in their recorded wealth, and the negative wealth effect causes them to drastically cut spending just when the economy is already weakening. This exacerbates the downturn, which in turn can cause the prices of a wide range of assets to fall even faster. In China’s case, three decades of rising real estate prices, increasing liquidity, and high real estate and infrastructure investment have been important conditions for the economy as a whole. Chinese households, businesses and financial institutions have factored this into their operating and financial assumptions. The problem now is that they have incorporated too many risks in a similar way, so that any adjustment or shock affects a large part of the economy at the same time and in the same way.
There are always feedback loops in the process. In the case of China, the first relevant feedback loop was from rising real estate prices, to rising real estate development and rising government revenues, to rising government spending on infrastructure and services, to rising growth expectations generated by real estate development and government spending, and to further rising real estate prices. Reversing this loop may lead to an opposite, self-reinforcing process of falling property prices, slower growth, and lower government spending. Beijing’s rapid responses to curb financial contagion from Evergrande’s problems in 2022 show that Beijing clearly recognizes that this is a systemic problem, not just a few poorly managed banks. China needs to slow the pace of investment adjustment in perpetuity, but this comes with further costs. A prolonged period of debt rising faster than the country’s debt servicing capacity increases the risk of disruptive financial adjustment. Unlike Western countries, however, the Chinese state is in a position to intervene more profoundly in market processes.
Actually we have new problems: The giant developer Country Garden, with total liabilities of $200bn, is days away from default after missing payments on dollar loans issued in Hong Kong. Like other developers relying on China’s “pre-sale” model it depends on a constant flow of new buyers to cover old debts.The buyers have dried up. The CRIC Research Centre says sales in July by the top-100 developers were just 30pc of levels three years ago. Its a Ponzi-Scheme, like Minsky would say. The developers have debts of $5 trillion. By comparison, this is six times greater than America’s $800bn subprime property debt on the eve of the Lehman crisis. They rely heavily on the $3 trillion ‚trust‘ segment of the shadow banking nexus known. The property bubble is the Ponzi scheme that keeps China’s local governments afloat. They rely on property for 38pc of total revenue, mostly from land sales. These sales have collapsed. The finance ministry says local government income fell 21pc in the first half of 2023. This must lead to a severe fiscal squeeze unless Beijing comes to the rescue with a huge stimulus package stimulus.
translated by deepl.