Chinese President Xi Jinping must strike a delicate balance between eliminating China’s crushing debt and maintaining consumer confidence. A misstep could spur global chaos, both economic and political.
Mark Schiefelbein-Pool/Getty Images; Samantha Lee/Insider
China’s economy – the 2nd-largest in the world – is teetering on the brink of disaster.
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.”
As the government now attempts to deflate the real-estate bubble without bursting it, it has been forced to prepare the country for a period of slower growth and belt-tightening. And to make matters worse, China is also facing an energy crisis fueled by skyrocketing coal prices as well as a working-age population that is getting old without enough resources to retire on.
In the face of all of these obstacles, Beijing has made a dubious choice. Instead of continuing to open the economy to spur growth, the Chinese Communist Party is closing it. Under President Xi Jinping, Chinese socialism is reverting to a model not seen in decades, with tighter state control over much of the economy. That’s why you’re seeing Beijing cancel massive IPOs and level entire industries. Economists expect this ideological shift to slow growth even more, which in turn would make China’s attempts to transform its economy that much 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 state control won’t be easy to manage, and there’s much at stake – for all of us. If Beijing fails at its ambitious plan, it could set off shock waves that would crater the global financial system, slow trade, and devastate businesses worldwide. The resulting chaos, and the crisis of faith in the CCP that would accompany it, could lead to social instability in China, spurring the central government to place an even tighter grip on civil society.
In short, Beijing is walking an economic high-wire act, trying to replace its economic model with something unknown. In the process, the weight of its old, debt-ridden system is causing China to wobble. And if the country falls, it could take the rest of the world with it.
What China is and how it came to be
If you want to pinpoint the moment that set China on the path to where it is today, you have to go back to 1984. That’s when Deng Xiaoping, chairman of the Communist Party, approved the Decision of Reform of Economic Structure, which rewrote the rulebook for the Chinese economy. Instead of the state directly operating every industrial sector, it would now allow state-owned businesses to flourish without direct government involvement.
That ideological flexibility – combined with the country’s creation of a modern banking system – paved the way for the emergence of privately-owned companies. Freed from direct government oversight, and flush with free-flowing loans, China’s manufacturing sector boomed. People from rural areas flocked to fill the privately-owned, debt-built factories, and a middle class took shape. In 1992, 27% of the country lived in urban areas. By 2020, the number had grown to 61%.
All of this growth was supercharged in 2009, during the global financial crisis. Seeking to avoid a downturn, the CCP ordered banks to spray loans all over the economy, especially to the property sector. But as the debt bubble grew, the new buildings remained empty. Despite the booming economy, many Chinese weren’t making enough money to afford the homes they were building or the goods they were producing.
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.
china apartment construction
Chinese developers have used debt to build thousands of office and apartment buildings that are still sitting vacant – and now pose a threat to the economy’s stability.
Zhang Peng/LightRocket/Getty Images
The following year, Beijing started the process of slowly working the debt out of the system. It allowed some companies to default on their loans, ordered local governments to shut down redundant factories, and shuttered coal mines that were no longer needed to supply them with energy. But as extreme as these efforts were, they barely made 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.
Chinese socialism is changing (again)
In an attempt to revive the Chinese dream, Xi is pushing the idea that China is moving toward “common prosperity.” But exactly what that means is hard to say. It could mean higher taxes for the high-income citizens who benefited most from privatization – the generation of supertycoons who were allowed to “get rich first,” as Deng Xiaoping urged. Or perhaps it’s simply an attempt, using the socialist rhetoric of old, to steel citizens for more volatile times ahead. But either way, it won’t help matters if Xi’s common-prosperity agenda turns out to hurt the country’s new middle class.
The only certainty is that China is returning to extreme state intervention, private industry be damned. In the starkest example of state control, China wiped out its entire for-profit education sector in July, sending markets in the US, where some of the 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.”
Part of the upheaval, it’s important to note, is also about power. By moving to rein in China’s wealthiest citizens, Xi is effectively hoarding power for himself and the CCP. Jack Ma, the billionaire founder of Alibaba, was once a ubiquitous presence in Chinese society. But since the government started clamping down on his businesses, he’s largely disappeared from view. The founder of ByteDance, the company that owns TikTok, also stepped down as CEO, saying he preferred “solitary activities.” Even online fan clubs for pop stars are being regulated to encourage devotion to the party. Last month, the former chair of China’s top liquor maker was sentenced to life in prison for taking 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.
Jack Ma Alibaba Founder China
Tycoons like Jack Ma, the founder of Alibaba, have been avoiding the spotlight as the Communist Party cracks down on private enterprise in a bid to consolidate power.
Mark Schiefelbein/AP Photo
And things have a good chance of going awry. As Beijing tries to move the economy toward a new, more insular model, it will have to avoid the land mines left by the old one.
Consider Evergrande, now teetering on the edge of default. Xi’s willingness to tolerate the credit squeeze on big developers shows just how committed he is to remaking the economy. Last summer, to deflate the property sector, Beijing introduced new credit metrics known as the three red lines. Developers were required to hold more cash so they could cover their indebtedness if things went sideways. Evergrande couldn’t raise the money – and it’s not the only one. Earlier this month Fantasia Holdings, a luxury-property developer, defaulted on a $206 million bond payment.
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 authorities is: ‘Don’t pull the funding so these units can’t be completed, but don’t fund an aggressive expansion of more new developments either,’” Chu told me. Once again, walking a tightrope.
The property fiasco also means Beijing needs to run a confidence game on two fronts. Investors need to believe the Chinese government can figure out how to restructure the most indebted property developers without causing a sudden crash for the real-estate sector – a task that will become more difficult as more developers show signs of strain. And consumers need to have the confidence that buying homes with cash in the midst of a credit crunch is a smart move, in the expectation that property values will keep rising. “If confidence in presales tumbles, that could be game over,” Chu said. “It would bring everything to a halt immediately.”
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.
The balancing act would be tricky to manage under any circumstances. But it’s made far more difficult by China’s sudden energy crisis. Electricity prices have more than doubled this year, as pandemic lockdowns lifted and demand for goods soared. China’s domestic coal stores were already down, thanks to the government’s earlier wave of mine closings, and Beijing made things worse by banning coal imports from Australia, which was pushing to investigate the origins of the coronavirus pandemic. Factories in 20 of China’s 31 provinces have suffered a loss of power, and companies including Tesla and Apple have said the crisis will hurt their supply chains. If Xi is initiating a power grab, it will be hard to pull it off without power.
Someone find the off ramp
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 else, we must defend – to the hilt – our economic interests,” Tai said. That’s not what America sounds like when it’s cutting another country some slack.
President Joe Biden and Chinese President Xi Jinping.
As President Xi Jinping reins in for-profit companies, President Joe Biden has made clear that America will, in the words of his trade representative, “defend to the hilt our economic interests.”
Paul J. Richards/AFP/Getty Images
But all the saber-rattling isn’t likely to alter the economic reality. China has no real option at the moment but to slow its growth, and a slow-growth China will inevitably act as a brake on the global economy. As Joyce Chang, the global head of research for JPMorgan, observed in a recent talk, a 1-percentage-point decline in China’s growth takes half a point off global growth. Morgan Stanley estimates that from 2022 to 2025, China’s growth will be 0.4 percentage points lower each year than previously estimated – and that’s the best-case scenario. If investment contracts sharply, China’s growth could drop by 1.2 points lower each year – which in turn would depress economies worldwide.
China’s slowdown will most directly affect its near neighbors in Asia – South Korea and Taiwan – as well as energy and commodity suppliers, like Russia and Norway. And the entire world will feel the weight of China’s weakness through slower, more expensive exports. What’s more, the economic repercussions will almost certainly be accompanied by social upheaval. The Stanford economist Scott Rozelle worries that Beijing will respond to any threat to its authority by ratcheting up nationalistic 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.