What this covers
The world’s second-largest economy experienced the largest credit boom and bust in recent history. On this episode of The Big View, Logan Wright of Rhodium Group explains why debt, deflation, slow growth and industrial overcapacity will be hard to shift in the People’s Republic.
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China's economic miracle has fundamentally broken due to a massive credit boom-and-bust cycle, leaving the country trapped in decay rather than crisis, with severely impaired policy tools and declining domestic demand that is driving aggressive export behavior with deflationary consequences for the world.
- China experienced the largest credit boom and bust in at least a century, expanding a third of global GDP in new credit in 8 years then cutting credit growth in half, leaving policy levers (state-directed credit and local fiscal spending) highly impaired
- Official GDP statistics are significantly inflated; actual growth is likely 1.5-2% over the past four years, not the claimed 5%, evidenced by negative investment growth, flat government spending, and persistent domestic deflation despite claimed 5% growth
- Xi Jinping's policy choice of managing decay rather than undertaking painful reforms, combined with centralized political control, has eliminated consensus-driven decision-making and created credit risk cascading from periphery to center of financial system
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Japan's population peaked in its working age around 2002-2003 and absolute population peaked around 2010, while China is about 10 years behind on both metrics but with sharper declines, suggesting China will lose 50-60 million people (3-4% of its population) over the next decade.
“Japan's population peaked working age population peaked in 2002 2003 absolute population peaked in 2010 or so China's about 10 [34:35] years behind in those metrics but the decline is sharper um in China on both metrics in terms of the working age population and um just in percentage terms um and in terms the absolute total population. So that really does limit I mean our own analysis suggests that China will lose something around 50 to 60 million people you know 3 to 4% of its population over the next decade.”
Nothing has replaced the impact of the property sector collapse because there's no single industry that can offset that kind of impact, meaning the hope that new growth drivers will replace real estate is mathematically impossible.
“nothing has replaced it because there's no single industry that can really offset that kind of impact in the property sector local government in infrastructure investment is also slowing because aggregate credit growth is slowing.”
People have mistaken credit for planning acumen and competence in the Chinese system, similar to the Steve Eisman quote about mistaking leverage for genius; everyone looks smart during credit expansions but less so during contractions.
“the famous quote about the financial crisis uh from Steve Eisman or or or someone else that you know they mistook uh leverage for genius right I mean people have mistaken credit [4:52] for planning uh acumen and competence uh in the Chinese system. Everyone looks really smart in credit expansions. Everyone looks a bit more on the back foot during credit contractions.”
Xi Jinping's centralization of power has shifted China from a consensus-driven leadership model where the party apparatus and state technocrats shared authority to a centralized leadership where the party and Xi's directives are paramount, fundamentally changing the nature of financial risks in the system.
“this centralization of power and this [20:34] has been a process through over time Xiinping has strengthened sort of the party apparatus relative to state technocrats and in the past China basically operated on a consensus driven leadership. Now, what that consensusdriven leadership meant was that people did not think that financial risks were likely within the Chinese system because basically the government didn't want political instability. [21:05]”
China is not experiencing a financial crisis in the mechanical sense, but rather experiencing the consequences of a financial crisis, which include slow growth, deflation, impaired balance sheets, slow credit demand, and reliance on external demand, exactly mirroring what would be expected 5 years after a financial crisis date.
“rather than the consequences of a financial crisis, I would argue what China is seeing is, you know, rather than a financial crisis in [8:59] its mechanics, what China is seeing is the consequences of a financial crisis. What do you expect in the years after a financial crisis? you expect slow growth, deflation, impaired balance sheets, slow credit demand um and a reliance upon external demand rather than uh being able to maintain domestic growth. This these are exactly the consequences we have seen in China from 2022 to 2025.”
Even gains in domestic productivity in new industries don't change the structure of final demand for China's products because the marginal demand for everything China produces is still outside of China rather than inside China, so efficiency improvements cannot solve the demand problem.
“the issue with China's new industries is [28:52] that even gains in domestic productivity don't change the structure of final demand. So that you know if you have the world's most advanced robots... the marginal demand for everything that China produces is still outside of China rather than inside of China, right? And so it's one thing to make that production more effective. It more efficient um but it doesn't change the [29:22] actual capacity of Chinese consumers to buy these products that are produced with these more efficient processes.”
Decay is the political choice China has made because decay presents no memoranda or crisis to manage; authorities try to smooth over problems today to prevent immediate crisis even though this doesn't forestall the forces producing the same pressures the next week or month, whereas reform involves writing down the capital stock and telling local governments, state-owned enterprises, and other actors who loses.
“one of the central arguments of the book is that decay is the political choice that China has made. Decay presents no memoranda. It presents no crisis to [19:31] manage. You just try to smooth over these problems today in order to prevent a crisis today even though that doesn't actually forstall the forces that produced uh those same pressures uh the next week or the next month. Decay is easier than reform because reform involves writing down the capital stock. It involves telling local governments who loses. It involves telling stateowned enterprises who loses. And those are difficult political choices.”
The Japanese experience with balance sheet recession shows that Japan could use fiscal policy (since monetary policy was at the zero bound) because companies were deleveraging, but China cannot use fiscal policy because it already has large fiscal deficits and 'the last mile of fiscal policy is clogged', creating different fundamental constraints than Japan faced.
“I sort of ascribe to the the Richard coup balance sheet recession argument in Japan. Um it there's but the big difference is with that Japan could use fiscal policy um because monetary policy was already at the zero bound and there was no credit demand because companies were deleveraging and so therefore they they had no credit demand overall. In China um you can't use fiscal policy. You already have very large fiscal deficits [34:04] and the last mile of fiscal policy is clogged.”
When Wright started researching his dissertation on China's exchange rate regime in 2003, he found the Chinese system extremely open, with officials willing to meet and discuss policy, but this accessibility changed around 2011 with the Middle Eastern protests, the rise of the security state, concerns about color revolutions, and periods of political instability in China.
“I was so shocked when I started I started researching a dissertation concerning China's exchange rate regime um as sort of this indicator and enabler of financial reform in 2003. And so I basically just sort of set about trying to go to conferences, trying to go to events and introduce [24:43] myself and meet people... I was so shocked how easy it was... What changed, I think, was around um the [25:46] 2011 Middle Eastern protests and the rise of the security state and concerns about color revolutions”
China's property sector was around 20 to 30% of the economy (reasonably estimated at 20 to 25%), with new housing starts down 77% from their peak and new sales down over 50%, causing an aggregate impact on employment, household net worth, consumption, and industrial output of at least 10 percentage points of GDP.
“China's property sector was around anywhere you want to measure it 20 to 30% of the economy. I think 20 to 25% is a reasonable expectation. New housing starts are down 77% from their peak. New sales are down over 50%. um the aggregate impact of this kind of decline on employment on household net worth on consumption um and just on upstream you know on and on on industrial output and overall demand is [11:39] enormous and it's at least you know 10 percentage points of GDP um in our view”
Countries can no longer be incentivized to maintain trade relationships with China if China's economy isn't growing and if there's no growth in Chinese imports, because China has less to offer.
“you can no longer incentivize countries to maintain the same trade relationships if your own economy isn't growing and if there's no growth in imports.”
The expansion of a third of global GDP in new credit in just 8 years after the 2008 global financial crisis represents the largest credit boom and bust in at least the last century, and since 2018, credit has been cut in half, with credit growth now about a third of its previous pace.
“in other words, if uh we had this enormous reconsideration or you know rethinking of where China's growth prospects were after the pandemic and after the collapse of China's property uh sector, but China's continued to publish, you know, very stable growth rates. Everyone knows there's something wrong with them, but people don't know um how much lower growth is. And more importantly, and the reason I wrote the book is no one really understands the story... the expansion of a third of global GDP in new credit in just 8 years after the global financial crisis. Since that time and starting in 2018, credit has been cut in half. Credit growth has been cut in half. Now credit growth is about a third of its [5:22] previous pace.”
The moment China reduces monetary rates, 'the external valve is the exchange rate' because lower rates will push capital out of China, forcing currency depreciation, which would worsen trade tensions and is politically costly.
“You can still use monetary policy by reducing rates but the moment you do that the external valve is the exchange rate.”
The rest of the world needs to collectively respond to China's persistent export of deflationary and de-industrialization pressures by investing in alternatives and new capacity, because Beijing cannot change course due to lacking the policy tools to do so.
“simply put, um the world needs to collectively think about how to respond um to these pressures... the message is that um you should not expect Beijing to change course on its own in part because it lacks the tools to do so.”
Most analysis of the Chinese economy looks at it through a political lens, viewing it as a one-party state with a technocratic elite that can make long-term plans, rather than from a financial system view that recognizes it as a country that has undergone a massive credit boom and bust and therefore has far less state capacity than when it started.
“Most people tend to look at China and this is not a fault of um analysis. It's just the way that people understand it through a political lens. So they tend to look at the Chinese economy and say this is a one party state with a technocratic elite and that that therefore this technocratic um planning oriented elite can make long-term plans that benefit the state [3:48] and therefore the way we need to understand the economy is through those long-term plans made in China 2025 for example... if you take a financial system view of China, this is [4:21] a country that has had a massive credit boom and bust... we simply do not uh we should not think that a country that's undergone this kind of credit bust has the same state capacity as when they started.”
Credit risk in China has cascaded from the periphery toward the center of the system: peer-to-peer lending networks in 2018, small banks in 2019, trust companies (non-bank lenders) in 2020, property developers in 2021, individual mortgage loans in 2022, and local government financing vehicles and state-owned companies starting to face credit risks in 2023.
“credit risk has spread from peer-to-peer lending networks in 2018 to small banks in 2019 19 to trust companies, these non-bank lenders. In 2020, there were protests on the streets of Shanghai in 2020 when many of these um you know went bust even among high- netw worth individuals. Property developers failing [23:08] in 2021, individual mortgage loans coming under pressure in 2022 and local governments, local government financing vehicles and stateowned companies starting to face their own credit risks in 2023.”
Consumption in China has weakened but not collapsed (up about 1% by retail sales proxy), whereas investment has been negative, showing that the economy has hit a wall in terms of ability to maintain investment-driven growth.
“Consumption has weakened but it hasn't collapsed. So we think that the decline in aggregate investment from [12:09] 2021 to 2025 was about 9% of global investment... consumption is up about retail as proxy through retail sales is up about 1%.”
The behavior of Chinese authorities in September 2024 (Xi visiting Gansu province, seeing local governments running on fumes with unpaid civil servants, then ordering stimulus) suggests either A) Chinese officials and Xi don't understand the economy or B) the official data does not explain what's happening on the ground, with the latter being more probable.
“Xiinping went to Gansu province in September and he saw that local governments were basically running on fumes. You know, they had very little activity happening. Civil servants were not being paid. um social services were being cut back. And so he went back and said, you know, we're really going to try very diligently to hit the growth target this year, suggesting that that was not in progress... you can conclude one of two things from looking at that. Either A um Chinese officials and Xiinping do not understand [16:55] what's happening in the Chinese economy. I think that's improbable. Or B, the data do not explain what's actually happening on the ground.”
The threat from China has changed from representing long-term systemic economic rivalry to representing a threat of de-industrialization, weaponization of supply chains, and exporting of deflationary and disinvestment pressures, driven by weakness in domestic demand.
“The threat from China has changed. It is now a threat about to the west about de-industrialization [10:04] about uh weaponization of supply chains. It is not a threat from long-term systemic economic rivalry in the same way.”
Chinese policy makers initially asked how to avoid Japanification, but now the question has shifted over the past 2-3 years to how to make Japanification work because it seems underway, and the focus is on managing within this structure rather than escaping it.
“I spend a lot of time in Japan now too for exactly the same reason talking to Japanese [33:00] economists who are interacting with Chinese economists who have made these visits and they described this evolution over the last two to three years just as well at first um we um you know at first the question was how do we avoid japanification and the second question was okay and like two or three years later now it's How do we make chapanification work because it seems to be you know underway underway in China and and what can we do to manage within this uh within this [33:32] structure.”
58% of all new loans in China are extended at or below the loan prime rate, meaning they are largely unprofitable and likely extended to state-owned borrowers, indicating the financial system cannot pivot toward new growth drivers despite stated policy intentions.
“you still see the fact that 58% of all new loans are extended at or below the loan prime rate, which means that they're very largely unprofitable and [28:20] likely extended to stateowned borrowers.”
Chinese technocrats did not anticipate the tightening of the Chinese public sphere or the centralization of power under Xi, and were surprised by these developments.
“I still think that it's important to understand that none of these financial technocrats and none of the people within the system would have [26:48] anticipated this tightening of the Chinese public sphere nor would have anticipated I think the centralization of power in China either.”
Electric vehicle sales in China are being propped up by subsidies, and now that some of those subsidies are rolling off, domestic auto sales are down 20% and even EV sales are negative, forcing manufacturers to export at lower and lower prices instead of capturing domestic demand.
“electric vehicles is a perfect example. A lot of subsidies propped this industry up at the beginning, continue to prop up sales. This year, some of those subsidies are rolling off. Uh domestic um uh auto sales are down 20%, even sales are negative. Um instead, China is going to export somewhere around 9 to 10 million cars because that's where the marginal demand is and it's happening at lower and lower [29:54] prices.”
No economy in recorded history has grown at 5% in real terms over 3 years while experiencing 3 years of domestic deflation, which China is allegedly doing, making the official narrative extremely implausible.
“Have you ever seen an economy that has grown at 5% in real terms over 3 years with 3 years of domestic deflation? I I have never seen one um in economic history. I'm sure, you know, maybe if you go back far enough, you could probably you could probably trace one out of the statistics, but it seems incredibly unlikely that the second largest economy in the world would be facing this kind of deflationary pressure when it is an investment economy.”
If growth were actually 4.5-5% in real terms, we would not be talking about Chinese excess capacity or expanding trade surpluses.
“if growth was actually 4.5 to 5%. We would not be talking about Chinese excess capacity. we would not be talking about China's uh trade surplus uh expanding to this to this extent.”
Xi Jinping is not a reluctant reformer but a failed reformer who attempted reforms outlined in the 2013 third plenum reform agenda but quickly backed away from them after the consequences were severe, particularly during the 2015 balance of payments crisis and stock market bailout that placed China's economic competence in question.
“Xiinping is not a reluctant reformer as much as a failed reformer. And what I mean is Xiinping attempted several reforms as outlined in the third plenum reform agenda in 2013 but quickly backed away from them after the consequences were so severe particularly during this period of the balance of payments crisis in China in 2015 and the stock market uh bailout at [19:00] that time which really placed sort of China's economic competence um in question um at that stage.”
Consensus-driven leadership in pre-Xi China created investor confidence that certain outcomes (like property market collapse) were unlikely because actors had veto power over decisions.
“people did not think that financial risks were likely within the Chinese system because basically the government didn't want political instability. So, local governments, if you thought that the this was very common in the 2010s, you would hear the property market cannot collapse in China because local governments depend on it. But implicit in that argument was the idea that local governments could have their way within um the national leadership and therefore you you could bet on local governments operating based on this sort of consensus driven leadership.”
China's official GDP statistics show growth slowed to just 4.3% in the second quarter of the year, which most economists believe are exaggerated.
“Even official GDP statistics, which most economists believe are exaggerated, show Chinese growth slowed to just 4.3% in the second quarter of the year.”
Beijing no longer uses carrots (incentives) to maintain trade relationships and now uses sticks (export controls) in response to de-risking; China is talking about responses to the European Industrial Accelerator Act and further restrictions on intermediate components, rare earths, and other exports.
“China now uses more sticks than carrots to try to push back against um de-risking steps. They are now talking about, you know, responses to the European Industrial Accelerator Act. They're talking about further, you know, restrictions on intermediate components, rare earths, um, you know, other export controls that are broadening.”
If straight-line trends in China's export share continue from 2022-2025 through 2030, China will raise its share of global exports in volume terms by another 9 percentage points by 2030, but will do so at the expense of pricing and profitability.
“by our projections, if uh straight line trends continue um in terms of China's export share within [37:41] multiple industries, if the the the trends continue from 2022 to 2025 on to 2030, China will basically raise its share of global exports in volume terms by another 9 percentage points by 2030, but it'll do so at the expense of um pricing and expense of profitability.”
There were protests on the streets of Shanghai in 2020 when many non-bank lenders and trust companies went bust, affecting even high-net-worth individuals, indicating the breadth of China's financial stress.
“there were protests on the streets of Shanghai in 2020 when many of these um you know went bust even among high- netw worth individuals.”
Evergrande was the largest company in China's largest industry, had taken on debt equivalent to Finland's GDP (approximately $310 billion), and collapsed in September 2021 when its own employees requested repayment for short-term loans they had provided from their own salaries, creating a bank run on a non-bank entity.
“Everrand was the largest company in the largest um was the largest company in the largest industry um in China they had taken on debt [7:58] equivalent to the gross domestic product of Finland at the time you know 310 billion dollars and they collapsed very quickly in September 2021 when their own employees were requesting repayment for um short-term loans that they had provided out of their own salaries and uh in in many cases.”
China can cite The Coming Collapse of China (published 2001) as an example of long-standing predictions of its imminent failure, suggesting that such predictions have repeatedly proven wrong and therefore current pessimism should be discounted.
“there was I think that the first the first sort of modern book I can remember is was called the coming collapse of China by Gordon Chang which I think was published in 2001.”
While China is keeping up with the US on artificial intelligence and advancing in robotics, these successes might be less compelling if China hasn't cleaned up its fiscal and financial system and the old drivers of growth.
“China seems to be keeping up with the US on artificial intelligence. So [snorts] is there not a a story here which is that those industries can be the sort of the engines of growth in the future even as they're sort of grappling with the with the hangover from from from real estate and infrastructure. Yeah, I mean that's it is a plausible story. Mathematically it doesn't really add up in terms of macroeconomic growth just based on the size of those industries relative to the property sector.”
The world's second largest economy is grappling with fallout from an epic real estate slump, itself the result of a massive debt-fueled construction binge following the 2008 global financial crisis, with a Byzantine financial system creaking with bad loans while local governments struggle to finance day-to-day spending.
“Yet, this rosy narrative obscures a glooier economic picture. The world's second largest economy is grappling with the fallout from an epic real estate slump. Itself the result of a massive debtfueled construction binge following the global financial crisis of 2008. China's Byzantine financial system creaks with bad loans while local governments are struggling to finance [1:07] day-to-day spending.”
New strategic industries (electric vehicles, AI, robotics, solar panels) comprise approximately 6.3% of GDP in upstream and downstream impact, roughly the same size as the property sector today even after its decline, so mathematically cannot grow fast enough to offset the loss of property and infrastructure investment.
“adding up the new strategic industries. we get to about 6.3% of GDP in upstream and um downstream impact and that's roughly still the size of the property sector today even after its adjustment >> after the >> even after the decline. So in other words, it's it's not that these cannot grow, but they they really cannot grow fast enough with a constrained fiscal and financial system to offset the impact >> of um of the decline in not only property but infrastructure investment”
Rodeium estimates that aggregate growth over the last four years has been in the range of 1.5-2% rather than the stated 3-5%, based on the mathematical impossibility of nominal GDP growing faster than all its subcomponents.
“we think that aggregate growth is in the range of you know 1.5 to 2% over the last uh four years uh rather than what China has stated which is 3% growth in 2022 despite all the covid lockdowns despite a 40% collapse in property sector construction during that time”
China's trade surplus last year was a record $1.2 trillion, fueled by a surge in overseas sales of new products like electric cars, batteries, solar panels, and other products.
“Its trade surplus last year was a record $1.2 trillion, fueled by a surge in overseas sales of new products like electric cars, batteries, solar panels, and other things.”
Changing the structure of domestic demand is probably more important than changing technological progress for China's future growth.
“changing that domestic demand picture is probably more important than changing uh technological progress.”
China's economic system mistakes have not been inevitable, but rather are 'the byproduct of choices' that can potentially change over time.
“all of these changes in the Chinese economy, the current slowdown, none of this was inevitable. It was inevitable after you had a huge credit boom and bust that there would be consequences. The the fact that they're trying to paper over those consequences and extend this story, none of this is inevitable. This is the byproduct of choices. Those choices uh can change over time.”
China has become a powerhouse in electric vehicles, batteries, solar power, and green technologies, surprising observers like Tharsson who had documented China's failure to develop competitive combustion engine cars.
“China's become a absolute powerhouse in electric vehicles. much to the surprise of people like me who observed their failure to to develop combustion engine cars. Um it's done well in electric batteries, uh solar power, other sort of green technologies.”
Chinese technocrats and officials were perceived as strengthening China by opening the system; most central bankers and regulators were forthright and willing to talk with foreign researchers.
“China was very it was a very open system then and it was perceived as strengthening precisely because it was opening and this was you know I found most Chinese technocrats including you know many people who rose in the ranks of the central bank and the banking regulator over the next decade um you know to be very forthright um you know very um open to talking uh with foreign researchers”
In 2012, hedge fund managers in Hong Kong were convinced China would have a Lehman Brothers-style financial meltdown, which did not occur.
“I moved to Hong Kong in 2012 met all these hedge fund managers who who were convinced that China was about to have a sort of Lehman Brothers style financial meltdown.”
Companies and financial institutions have scaled back exposure to China, and there is discussion of 'decoupling' and rethinking supply chains, but most financial risks from China appear to be contained onshore.
“on the flip side, you might say, well, you know, companies and and uh and financial institutions have sort of scaled back their exposure to China a bit. I think there's the sort of whole decoupling idea. Um, people think rethinking supply chains and so forth. the financial risks. It feels like most of those are are sort of contained on shore.”
China's book title 'Broken China' is intentionally chosen to prompt the reader to think about what comes next, not merely as a bearish catchy title.
“the book is entitled Broken China, not because I'm, you know, trying to come up with a catchy, provocative, uh bearish book title, but to make people think about what comes next, what does this mean?”