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Shades of 2008 - Unprecedented Levels of China's Debt Threaten the Entire Global Economy

Shades of 2008 - Unprecedented Levels of China's Debt Threaten the Entire Global Economy
Scaling China's Great Wall of Debt Will Require More than Smoke and Mirrors

12 November 2018


GED Focus Paper: China’s “Great Wall” of Debt

The figures of the Chinese debts are subject to ongoing discussion among economists. Will the enormous rise in Chinese corporate and private debt lead to another global financial crisis or will it be managed by the Chinese government? If China’s debt management fails, the macroeconomic effects are expected to overshadow the catastrophic effects of the 2008 financial and economic crises by large.

DOWNLOAD: GED Focus Paper: China’s “Great Wall” of Debt


If China’s debt management fails, the macroeconomic effects are expected to overshadow the catastrophic effects of the 2008 financial and economic crises, making this a topic of endless fascination for economists.

During the crisis, global trade nearly collapsed. This meant a huge decrease in China’s exports, a sector that had largely fueled the country’s rise to a global economic superpower. Chinese factories closed and millions of workers lost their jobs.

The Development of China’s Debt

What happened next was unprecedented:

1. The government, concerned the spike in unemployment might lead to social unrest, announced the world’s largest stimulus package. The $600 billion plan was largely tuned to encouraging a massive boost to public infrastructure building (ThomsonReuters 2018). Now, the immense loan-financed infrastructure measures might backfire.



2. Lending increased to Local Government Financing Vehicles, state-owned entities created to raise funds for local government development projects, such as real estate or infrastructure. Recent uncontrolled lending to LGFV’s means local governments theoretically could become insolvent, if prices in the real estate industry collapse, leaving the central government to fill in and ultimately carry the macroeconomic risks. According to Huang Shouhong, director of the State Council Research Office, though, the idea that the central government will resort to bailouts when local governments suffer debt defaults would be an illusion.


3. The years after 2008 saw continuing growth of SOEs, many of which receive substantial support from the government. Chinese state-owned enterprises (SOEs) which account for about 20 percent of China’s total employment and can be found in all sectors of the economy, ranging from tourism to heavy industries ( July 25 2017). Non-financial sector debt-to-GDP has risen dramatically – approximating 250% in 2017. Yukon Huang of the Carnegie Endowment’s Asia Program says, “China’s debt problems are largely due to the poor performance of a subset of SOEs. But because many of the largest SOEs are seen as China’s ‘national champions’, the necessary reforms have been delayed” (Carnegie Endowment October 11 2017).


4. Driven by an almost uninterrupted property boom, household debt has exploded. China’s home ownership is now among the highest in the world at 89.68 %, rising from almost zero two decades ago. More than half of Chinese family wealth is now  held in the form of property, according to the Chinese Academy of Social Sciences (SCMP August 6 2017).  And lending could grow considerably higher: The IMF expects China’s debt concerning households as a percentage of its economic output to double by 2022 compared with a decade before: Household “credit growth to the real economy remains rapid with the credit-to-GDP ratio exceeding its historical trend by more than 25 percent of GDP” (IMF 2017: 40) (fig. 8).



5. The increases in size, complexity and interconnectedness of these exposures have resulted in rising risks most prominently in shadow banking, which is being used as a way to boost leverage and profits while avoiding regulatory hurdles. Its rapidly growing importance points to the fact that there is a considerable imbalance regarding the demand for new credit as well as its distribution and the re-labelling of assets and generous off-the-books lending has significantly decreased asset quality. If China’s debt bubble bursts, these claims might prove a menace to the banking system, which at 310% of GDP is not only nearly three times the emerging market average but also above the advanced economy average.


The Chinese government is caught between a rock and a hard place with political stability connected with stabile growth pitted against the macroeconomic realities of a global world. As long as China’s macroeconomic policy stays focused on a growth under all circumstances, however, it will continue to evade the fact that a lot of China’s debt is bad debt and ultimately should be written down (Shih October 7 2016). If this doesn’t happen, the IMF expects China’s non-financial sector debt to hit nearly 300 percent of GDP by 2022 (IMF 2017: 10)


The repercussions of a failure of the Chinese government to appropriately address the multitude of problems feeding into this growing debt bubble could be unprecedented. With its LGFV funding program, China bought time to delay the effects of the 2008 financial crisis. But, it is unclear if the Chinese central government will be able to effectively restrain the lending spree of local governments. If it fails to do so, it might be dangerous for the global economy to further depend on the growth of a country where economic rules continue to be made up rather than followed.

You may also enjoy reading our take on the question: Is China systematically buying up German key industries?


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