Why the Chinese Economy Is Doomed

A Chinese migrant worker passes by The People's Bank of China in Beijing on May 1, 2013. (Mark Ralston/AFP via Getty Images)

Commentary

Despite the endless stream of happy talk on China’s economy from state-run Chinese media, the communists are mortgaging their country’s future through incompetence and economic mismanagement.

Chinese leader Xi Jinping’s recent visit to San Francisco was a head fake to American capitalists who paid handsome fees to attend a “business dinner” on Nov. 15 and welcomed him with a standing ovation.

Something is amiss. Chinese media recently made some incredible statements that are contrary to the facts. Take, for example, this whopper from China Daily on Nov. 20: “Retail property houses huge growth potential in nation.” Or this one from China Daily on Dec. 4: “Worries about China’s reform unwarranted.” And another from Xinhua on Dec. 4: “China’s expanding logistics sector indicates steady economy.”

The reality is that Evergrande—once China’s largest property developer by sales—defaulted in 2021 and has been in the throes of debt restructuring that merely delays an almost certain bankruptcy. And Beijing’s “reform”—that is, the tightening of the screws on businesses through arbitrary enforcement of the new counterespionage and national security laws—has convinced many foreign companies to disinvest, divest, and relocate out of China.

As noted by Business Insider on Nov. 23, China’s share of the world’s economy is “on pace for a two-year drop of 1.4 percentage points, a slide not seen since the 1960s and 1970s, when Mao Zedong presided over a weak economy.”

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Clearly, the communists’ claims don’t square with reality. But there are other matters that they should be concerned about.

Moody’s Downgrades China

Moody’s Investors Service is “a global integrated risk assessment firm” that conducts economic forecasting and credit analysis of governments and businesses worldwide. In a shock to current and would-be investors in communist China (and to those who welcomed Xi at that business dinner in San Francisco), Moody’s “cut its outlook for Chinese sovereign bonds”—for example, China’s government credit ratings—to negative from stable because of rising concerns over the level of China’s debt, as reported by Bloomberg News on Dec. 5.

The specific concern is that the Chinese Communist Party (CCP) will be required to bail out debt-laden local governments and state-owned enterprises, putting significant financial risks on Chinese banks and the economy by diverting financial resources away from economic development investments to debt restructuring and servicing.

According to Moody’s rating system, Chinese bonds are rated at A1, which is fourth in its 21-notch scale and corresponds to the best rating for upper-medium grade bonds but well below the top AAA rating. Per Investopedia, an A1 rating “[signifies] that bonds are of high-quality and have many positive qualities, but do carry a slightly higher degree of long-term investment risk.” And with other ongoing CCP shenanigans, such as the Chinese military’s belligerence in the Taiwan Strait and the South China Sea, a higher degree of investment risk is causing foreign companies to reconsider investment/expansion in China.

The Elephant in the Room

Local government debt is the real drag on the Chinese economy, and for various reasons—economic ineptitude, corruption, and politics—Beijing either refuses to deal directly with the problem or doesn’t know how to resolve it. And that so-called hidden debt is huge and growing rapidly.

“Hidden debt” refers to all nonstandard and off-balance sheet borrowing on the part of China’s local governments that’s in excess of local government debt quotas and regulations.

As The Wall Street Journal noted on Dec. 5, “[the] International Monetary Fund and Wall Street banks estimate that the total outstanding off-balance-sheet government debt is around $7 trillion to $11 trillion.” That debt financed roads, bridges, and other infrastructure, as well as investments in local businesses and state-owned enterprises that have proven to be money losers over the years. And most of that debt is held by Chinese commercial banks.

Failure isn’t an option because of the stigma of communist mismanagement that would ensue, and, thus, that debt has been rolled over and extended for decades, resulting in trillions owed that may never be repaid. Local governments are forced to refinance their off-book debt by issuing special public bonds backed by Beijing. However, there are estimates that as much as $800 billion of that “hidden debt” is at high risk of fault because of the lack of sufficient local government revenues to make the interest payments, let alone pay off the debt principal. A few local defaults could start an avalanche that would destroy the Chinese banking industry.

Concluding Thoughts

Chinese economists (an oxymoron) appear to believe that for every economic crisis “nail,” the solution is a government “hammer.” GIS Reports noted on Dec. 5: “[When economic] crisis breaks out, Chinese authorities tend to intervene by manipulating financial markets and centralizing decision-making processes. As a result, the role of free-market mechanisms weakens, which does not bode well for future growth.”

In short, the communists don’t believe in Adam Smith’s “invisible hidden hand” of the market, which posits that a free and self-optimized market reaches equilibrium through the actions of individuals and the interplay of supply and demand. And they certainly don’t understand the importance of Joseph Schumpeter’s “creative destruction,” which involves intentionally dismantling established processes—including disruptive technologies, methods, and ideas—to pave the way for enhanced production methods. That involves an element of letting failing businesses fail and selling off their productive and useful pieces to reconstitute new enterprises.

The CCP’s failure to understand market forces and instead insist on direct government intervention to prop up failing local governments and state-owned businesses to determine winners and losers among enterprises is why the Chinese economy is spiraling downward. Communism never delivers for the people, and the Chinese are finding out that neither does Xi’s “socialism with Chinese characteristics.”

Views expressed in this article are opinions of the author and do not necessarily reflect the views of The Epoch Times.