Why China Won’t Suffer a “Debt Crisis”

In the West the financial system is fragmented – individual institutions are financially separate. As there is no unified financial system, the necessary transfer of resources from the state, to prevent collapse of “system making” institutions, is therefore external and chaotic. For example, following Lehman’s collapse, essentially every private Western bank had to be salvaged by government subsidies and direct nationalization. The same occurred with GM and Chrysler. In Greece the EU and IMF ordered partial bond defaults and bailout packages. The transfer of resources from the state, and in some cases private bond holders, was via the chaotic “crisis” way – the “Lehman moment.”

Basic laws of economics cannot be avoided, so if in China a substantial number of bad loans occur, as with banks in the 1990s, the state also has to transfer resources. But in China the core of the financial system is not fragmented, but a single integrated whole comprising central government, local governments, state banks, and large state-owned companies. Resources are therefore not transferred by chaotic crisis as in the West, but within this integrated financial system. China’s financial system could be conceptualized by the analogy of a single person transferring money from one bank account to another – for example from the central government to bail out local governments. Or, to put it more popularly, it is as though money is transferred from one pocket to another.

A transfer of resources from the state therefore takes place in China, as in the West, but in an orderly and not a chaotic fashion. That is why China never has a “Lehman moment” or a “Minsky moment,” a large-scale financial crisis – the superiority of China’s financial system to the West precludes it happening.

To avoid misunderstandings, this does not mean that large-scale bad investments made in China do not create problems. If, for example, a bad railway investment is made which fails to generate adequate users, the resources transferred within the system to bail it out preclude their availability to build a railway which is actually required. The problem therefore does appear in the form of systemic financial crisis, not for reasons outlined, but in the form of a decline in the economy’s overall investment efficiency, as resources are sucked into inefficient ventures at the expense of efficient ones.

The data on this latter process is clear. Every major economy suffered a decline in investment efficiency as a result of the international financial crisis. Taking the five years after the start of the financial crisis, the percentage of GDP that had to be invested in China for its economy to grow by one percent rose from 3.4 percent to 4.9 percent – China’s investment efficiency fell under the impact of the global financial crisis. But in the U.S. the percentage of GDP that had to be invested for the economy to grow by one percent rose from 8.1 percent to 33.1 percent! In other words, China came through the negative consequences of the international financial crisis much more successfully than the U.S.

Because they ignore elementary accounting rules, those claiming that China will suffer a severe “debt crisis” are writing financial fairy stories – they never actually occur.


JOHN ROSS is a senior research fellow at Chongyang Institute for Financial Studies, Renmin University of China. From 2000 to 2008 he was director of economic and business policy in the administration of Mayor of London Ken Livingstone. He previously served as adviser to several major international mining, finance and equipment manufacturing companies.


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