China’s Bad Dream

LONDON – Since his first address as China’s president last year, Xi Jinping has been espousing the so-called “Chinese Dream” of national rejuvenation and individual self-improvement. But the imperative of addressing the unprecedented amount of debt that China has accumulated in recent years is testing Xi’s resolve – and his government is blinking.

The Chinese government’s uncertain ability – or willingness – to rein in debt is apparent in its contradictory commitment to implement major structural reforms while maintaining 7.5% annual GDP growth. Given that China owes much of its recent growth to debt-financed investment – often in projects like infrastructure and housing, meant to support the Chinese Dream – any effort to get credit growth under control is likely to cause a hard landing. This prospect is already prompting the authorities to delay critical reforms.

To be sure, China’s debt/GDP ratio, reaching 250% this month, remains significantly lower than that of most developed economies. The problem is that China’s stock of private credit would normally be associated with a per capita GDP of around $25,000 – almost four times the country’s current level.

There are strong parallels between China’s current predicament and the investment boom that Japan experienced in the 1980s. Like China today, Japan had a high personal savings rate, which enabled investors to rely heavily on traditional, domestically financed bank loans. Moreover, deep financial linkages among sectors amplified the potential fallout of financial risk. And Japan’s external position was strong, just as China’s is now.