China has a huge stake in continuing economic growth.  For decades, Communism delivered little to the Chinese people but poverty and suffering.  Only a brutal police state kept the Chinese Communist Party (CCP) in power.  After the death of Mao, the CCP re-founded Chinese Communism.  Prosperity gained through rapid industrialization and entry into the global market would legitimize CCP rule.  Having made this bargain, the Party would have to keep the economy growing faster than either population or the expectations of the Chinese people.  A crash or even a serious slowdown would strain the Party’s claim to both omniscience and power. 

            China has an unbalanced economy.[1]  China laid the foundations for its post-Mao economic ascent with investment in heavy industry and mass production of consumer goods for export.  The Chinese have a high savings rate that limits the domestic demand for consumer goods, while also limiting the impact of foreign lenders.[2]  The government pursued a policy of easy money with interest rates held down regardless of market conditions. 

China’s excess of enthusiasm led to over-investment in productive capacity.  Even before the 2008 financial crisis, political considerations forestalled a clean-out, so mills and mines proliferated beyond actual demand.  The same forces prevented raising interest rates. 

            China responded to the global recession triggered by the American financial crisis of 2008 with a gigantic stimulus program.  After 2008, government-owned heavy industry splurged on adding more productive capacity in basic industries.  All of this happened because the central government provided easy credit.  Local governments did the same with their own locally-controlled businesses.  Private industry—notably property developers and construction companies—built whole “ghost towns” on credit. 

            China ended up with a more distorted economy as a result of that stimulus program.  “Zombie” businesses walked the land like a Chinese opera version of “Twilight.”  This led many Western observers to predict a financial collapse that would shake Chinese politics and society.  Why didn’t that happen? 

            China has robust means to resolve its economic problems.  It’s not a Western capitalist country or a democracy.  Real power rests with the Chinese Communist Party.  Zi Jinping has been consolidating control of the Party and of the government in his hands for some time now. 

China operates a powerful set of controls on capital flows out of the country, so the savings of the Chinese are readily available to the government.  The same controls help shore up the international exchange value of the currency. 

Ownership of so much industry and control of the banks allowed Zi to begin shoring-up the financial system from early 2016 onward.  China did what Japan had balked at doing years before.  It forced mergers and write-downs on loans, sometimes expanding the state’s ownership stake in businesses through taking equity positions.  The government pulled back on lending, both by banks and outside the banking system.   

Will these reforms suffice to hold off disaster?  Probably not.  Political concerns limited the clean-out needed for real stability.  Meanwhile, real estate and consumer debt have ballooned.  There’s always someone who says “This time it’s different.”  It never is different. 

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[1] Thomas Orlik, China: The Bubble That Never Pops (2020), reviewed by Edward Chancellor, WSJ, 27 July 2020. 

[2] Foreign lenders, operating with a more capitalistic mind-set, might well have tried to drag on the reins.