American playwright and humorist George Ade coined the maxim, “the higher they fly, the harder they fall,” toward the end of the Gilded Age more than a century ago, yet it rings true today. We are once again experiencing worldwide extremes of wealth and poverty, boom and crash, plus rapid technological and social change characteristic of Ade’s era. Perhaps no other phrase so aptly captures simultaneously the extremes of political ascendence and demise and the cyclical reversals of the business fortune, now once again so stark.
Then as now, business cycles are a necessary part of the capitalist credit cycle. There are always opposing interests, creditor and debtor plus bear and bull pushing in opposite directions with relative power that varies over the cycle. John Maynard Keynes described the contention between bears and in his 1930 work, Treatise on Money, which is unfortunately much neglected relative to his more famous book, The General Theory of Employment, Interest, and Money. During any boom, credit-fueled bulls accelerate business activity and asset prices, plus, typically, consumer prices. During the subsequent crash, tightening credit and higher interest rates bankrupt the most overextended bulls and enrich the bears who bet on a coming crash. When the bears are also big banks that control the flow of credit, they can realize those bearish bets in their own interest, restoring the real value of the credit asset portfolios as inflation eases or turns into deflation.
China, despite some ideological identification with socialism, has a credit-driven capitalist economy, no less than most other nations. Like many, China is today facing a recession because of bearish tightening of credit, not the lingering effects of COVID. If fact, the end of COVID lockdowns promised an economic resurgence, if the credit were forthcoming to fuel it. Briefly, there was a resurgence, but it is now faltering as both the demand for and supply of credit is waning.
Many pundits, who consider China’s economy to be more government-dominated than most, believe that China is recession proof because the government always has the monetary and fiscal tools to avoid a downturn. This is not so. Recessions are caused by fear of spending and fear of lending. No government can force confidence. If consumers and businesses are reluctant to spend and borrow, private sector output will fall. Increased government spending and borrowing could, in theory, make up some of the difference, as it did for China during the last global recession in 2008-2009, but that assumes that private investors will continue to have confidence that Chinese government debt is a worthy investment. Recent indications are that investor confidence in government bonds, especially those of heavily indebted local governments, is waning too.
There are several reasons why China’s economy is facing a credit crunch and recession. They include: (1) decreasing potential for export-led growth; (2) tightening credit, leading to a fall in investment-led growth; (3) weak consumer demand caused by long-term demographic factors and high unemployment, especially among the youth; and (4) falling spending, particularly by heavily-indebted local governments.
China has grown for four decades based on expanding its share of world trade, much like Japan did from the 1950s through the 1980s. Surpassing Japan at its 1980s peak, China has become the largest trading country in the world in recent years. While export-dependent countries are a relatively small portion of total world trade, they can grow much faster than the world market as a whole by taking market share from others, but once they become so big, there is little room for further growth at other’s expense. Furthermore, other countries begin to resist Chinese exports more. Trade growth must inevitably slow as an export powerhouse matures.
The other driving force behind China’s fast growth has been an extraordinarily high rate of investment, both in productive capital, such as factories, and real estate development. Such investment depends heavily on inexpensive credit. Yet now both the supply and demand for loans is falling. Demand for borrowing is falling because contractors do not want to risk building much more with real estate prices soft and much idle floor space already available in many markets. Likewise, industrial companies are postponing productive investments because both export and domestic demand are weakening, while many industries already have excess capacity. Supply of loans is falling because many creditors are already overextended and with many customers already over-borrowed, lenders are carefully scrutinizing new loans. For example, U.S. venture capital investment in China has plummeted 90 percent since 2021. Thus investment spending is no longer a major engine of growth.
The drastic slowdown in home purchases also depresses consumer spending. A major source of demand for all sorts of products is new household formation as young people move into housing. Demand is also slack because youth unemployment is very high at around 20 percent. High youth unemployment is one of several factors driving down the marriage and birth rates, which further depress consumer demand. The growing youth trend of tang ping (laying flat) reflects widespread despair about future prospects.
Increased government spending might stimulate growth when all over sources of demand are slack, but this too has problems. Much of the buoyancy of the real estate market had come from development projects funded by provincial, city, and township governments; however, many of these are now facing debt defaults. Goldman Sachs estimates that local government debt in 2022 was a whopping 156 trillion RMB or $22 trillion or 126% of GDP. Rhodium Group calculates that half of China’s cities are facing difficulties making interest payments on existing debt. Several provinces, including Guangxi and Yunnan, are already facing debt default. As a result, many government employees are paid late or suffering pay cuts, thereby exacerbating consumer anxiety. The central government, wary of the Chinese currency becoming too weak, is unwilling to borrow as aggressively either as interest rates rise.
China’s economic troubles have global implications. During the last major global financial crisis in 2008-2009, rising demand from Beijing’s stimulus spending helped boost the world economy out of the deepest recession in a generation. The world is once again on the precipice of a major crisis. Many developing countries, as well as Ukraine and Russia, are already suffering greatly from both rising prices and unemployment, reminiscent of the stagflation of the 1970s. This time China cannot be the engine of economic recovery. It will be deeply mired in problems of its own. China’s fast growth has seemed threatening to many, but its slowdown may be worse.
