Ouch. Joe Hockey would tend to differ, but would he know.
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Perhaps more dangerously, China’s loose money has also pumped up a mammoth increase in debt—like Japan’s in the 1980s. Ratings company Fitch shows that total debt relative to national output in Japan jumped almost 80 percentage points, to 275 percent from 1980 to 1989, on the eve of the country’s financial meltdown. The same ratio in China has risen steeply—more than 100 percentage points from 2007 to 2015, reaching 255 percent of its gross domestic product, according to the Bank for International Settlements.
There are economists who argue that China’s mountain of debt isn’t as risky as it appears. Since the debt consists to a great degree of loans made by state banks to state enterprises, the government is likely to step in and support the financial system. And because Chinese debt is almost entirely domestic and backed by massive savings, the financial sector is unlikely to fall prey to outside shocks.
The experience of Japan suggests otherwise. It, too, was a creditor nation with large trade surpluses and ample savings in the early 1990s, but that didn’t prevent a financial crisis. If anything, Japan is proof that a bubble-prone, debt-obsessed economy is susceptible to failure, no matter the circumstances.
Japan can provide China with a model of exactly how not to handle such problems. Rather than allowing indebted, struggling companies to fail, the Japanese kept many afloat with continued credit, debt-for-equity swaps, and other tricks. Such “zombie” companies drag down the economy to this day. To sustain growth, the government turned to artificial stimulus—deficit-financed spending on infrastructure and unprecedented printing of yen by the central bank. That managed to swell Japan’s total debt to almost four times its national output at the end of 2015 while failing to revive the economy. The meddlesome bureaucracy has never reduced regulation nor opened markets enough to spur competition, efficiency, and entrepreneurship.
Officially, China’s president, Xi Jinping, has embarked on a different course. He’s pledged to undertake a sweeping program of pro-market reforms that could shift the economy toward new sources of growth, scrub out excess and waste, and promote private enterprise. In practice, however, China is following in Japan’s footsteps. Despite promises to eliminate zombie companies, Beijing has kept them alive by flooding the economy with credit and state stimulus. In October government planners announced the details of a debt-for-equity swap plan ostensibly aimed at rescuing “good” companies, but more likely perpetuating excess capacity.
Meanwhile, China’s debt burden continues to get heavier, as the expansion of credit outpaces GDP growth. But that credit isn’t stirring the economy. As in Japan, a kind of paralysis is setting in that renders all that cash less effective. There are indications that more and more new credit is being used just to pay off old debts. That means less and less money is going toward investment that could boost the economy.
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