Paper Dragons: China and the Next Crash
By Walden Bello
Zed Books, 2019
While the rise of the Chinese economy has often been touted as a miracle, many economists have pointed out some alarming risks.
For example, China has one of the highest levels of debt in the world, in excess of the levels that crashed other economies in the 2008 Global Financial Crisis (GFC). In 2019 China’s total debt, including government and private, passed 300% of Gross Domestic Product (GDP).
In Paper Dragons, Walden Bello, a campaigner against corporate-led globalisation, looks at the economic dangers building up in the Chinese economy and situates them in world economic developments since the GFC. The main dangers that Bello points to in the Chinese economy can be summed up as an economic bubble see-sawing between real estate and stock market bubbles, coupled with a rise in shadow (unregulated) banking.
The success of the Chinese economy has been built on a huge growth in exports. As a result, according to Bello, the most powerful influence on economic policy has been the export lobby. Its influence means export industries enjoy a virtual monopoly on credit from big state banks. It has also successfully blocked liberalisation of interest rates, so interest paid on that credit has been kept low.
Along with this, China has had a very high national savings rate. In 2007–08, the national savings rate accounted for 53% of GDP, while household savings accounted for 22.9%.
But with interest rates being kept low, keeping money in a bank deposit has been an unappealing investment. Many, particularly those in the rising middle class, looked for a better investment and found real estate. Authorities, in an effort to satisfy these sectors of the public, also encouraged easy lending practices for property adding to the investment contributed by savings.The popularity of real estate speculation lead to the number of Beijing households owning two or more houses rising to 18%.
Being aware of how the United States economy in the GFC and the Japanese economy late 1980s were pushed into crises by bursting property bubbles, Chinese authorities have introduced some measures to curb speculation.
However, winding back speculation too far jeopardises cement, steel and construction industries, and risks contagion to the rest of the economy. As such, the measures have not been severe.
Low interest rates on deposits and uncertainty in real estate has in turn leant the stock market appeal as an avenue for investment. Chinese stock markets have seen some spectacular rises. Between mid-2014 and mid-2015, the Shanghai market index grew 150%. In dollar terms that is a growth larger than any other stock market in a 12-month period. It is larger than the entire US$5 trillion value of the Japanese stock market.
The steep 40% plunge that followed left many investors ruined, especially those who had borrowed to make the investments.
The power of the export lobby and its virtual monopoly on credit has also encouraged the rise of a shadow banking sector, to which other sectors can turn for credit. The shadow banking sector is made up of financial institutions outside the normal regulated banking system. They tend to deal in some of the more exotic financial instruments and are a means of keeping transactions, often involving excessive leveraging, off the balance sheets of financial institutions.
The shadow banking sector, and its highly-leveraged investments in things such as mortgage-backed securities and CDOs (Collatoral Debt Obligations), played a pivotal role in bringing about the GFC.
Bello cites a study that estimates that by the end of 2013, China’s shadow banking risk assets totalled US$4.7 trillion, or 53% of GDP. He also points out, however, that the global average is 120% of GDP.
A possible risk of crisis lies in the relation between shadow banking and the real estate sector, to which a significant proportion of shadow banking is connected. A bursting of the real estate market bubble would lead to a leap in non-performing loans and a crisis in shadow banking like that in the GFC.
In spite of the subtitle of the book hinting that China might be the epicentre of a new crash, the picture Bello paints of the global economy is no rosier than the picture he paints of the Chinese economy. Much of the book is a very good survey of the global development of the GFC and the responses to it.
In assessing the risk of a Chinese crash, Bello probably makes insufficient allowance for the potential of government intervention to prevent or ameliorate economic crises. Chinese capitalism is far from being free-market capitalism. The government has more levers to use in the economy than the governments of other major economies. It has also shown fewer ideological qualms about doing so, albeit this is contested and under pressure from different sectors.
Major sectors of the economy are still largely state-owned, in spite of the trend towards privatisation in the past few decades. This means it has more scope to use stimulus measures to direct investment productively. This contrasts to a more standard Keynesian stimulus, where governments merely pump money into the economy and cross their fingers it will be invested productively rather than merely pocketed, off shored or gambled on the stock exchange.
Notably, the banking sector is still largely state owned, giving the government more control over preventing or managing financial crises. However, as Bello points out, this is challenged by the growing shadow banking sector. The shadow banking sector is itself significantly dependent upon borrowing from the formal banking sector so its collapse would have a knock-on effect.
During the GFC, the US administration of George W Bush struggled to get lawmakers to approve its bailout package. As the economy headed for an even worse crash than that underway, lawmakers were so ideologically committed to the free market that they refused to accept government intervention. This was the case even when that intervention was primarily directed at rescuing the major capitalist financial institutions.
In Europe, governments pushed austerity measures as a response to the crisis, helping contract their economies just as they were headed into trouble.
The Chinese government, however, responded to the GFC with a stimulus program of US$585 billion. Relative to the size of its economy, this was far bigger than Barack Obama’s US$787 billion US stimulus program, which had to be watered down to appease free market ideologues. As a consequence, China’s growth was slowed by the GFC but stayed well away from falling into recession like most economies.
That said, such measures may be more adept at ameliorating crises, but they cannot solve underlying problems. China clearly has some serious ingredients for an economic crash.
The same, however, can be said for much of the rest of world. There’s no clear answer as to where the trigger for the next crash will come from, but there is significant scope for it to spread when it does.