Even if there weren't a trade war, China would be in crisis

The Chinese economic crisis has been a below-the-radar story for more than a year as the once mighty Chinese economy is in free fall.

The trade war with the United States certainly hasn't helped matters, but the crisis in the Chinese economy predates the tit-for-tat tariffs the two sides have imposed on each other.


Once again, the world's investors are turning their worried gaze toward China.  And for good reason.  Economic growth in the third quarter sank to 6.5 percent, the slowest pace since the depths of the global financial crisis in 2009.  Car purchases fell last year for the first time in more than two decades.  Apple Inc.'s warning in early January that iPhone sales in China were sagging alerted the world to how a slowing Middle Kingdom would drag down global growth and corporate profits.  But the locals figured that out a while ago.  Even after a recent uptick, the stock market in Shanghai has still plunged by more than a quarter from its 2018 high.  The outlook isn't any rosier.  Tariffs on Chinese exports to the U.S. imposed by President Donald Trump are starting to pinch the country's factories.  A steep and unexpected plunge in imports in December signaled just how sharply the economy is decelerating.  That's led Beijing to turn the volume down on its bravado and negotiate with Washington to defuse the conflict.

As Bloomberg notes, an end to the trade war would cheer investors and give a boost to the Chinese economy – temporarily.  China's real economic problems are structural and systemic:

Meanwhile, the economy is weighed down.  Too much of China's debt has been amassed in unproductive ways – unnecessary factories, insolvent "zombie" companies – and that gross misallocation of resources is eating away at key drivers of growth.  The New York-based Conference Board, a research association, figures total productivity growth in China has been negative since 2012.

All this leads to a downward spiral.  With the nation already buried in debt, each attempt to stimulate the economy with fresh credit has a smaller and smaller payoff.  As research firm Fathom Consulting explained in an October study, China's old economic model "is exhibiting diminishing marginal returns."  There are signs of that happening.  Despite months of prodding lenders, credit growth has not picked up steam as policymakers have wished.  Heightened anxiety over the economy combined with the already staggering level of debt is making it more difficult for the government to rely on additional credit to keep China growing.

You can't take a couple of trillion dollars out of the global economy without negative effects.  The only question is how severe China's problems will get and how expensive the fix might be:

The underlying issue is that the liberalizing reforms that could set the economy on a healthier track have all but evaporated, and there's no revival on the horizon.  President Xi Jinping's top priority is imposing Communist Party control on everything, so he's kept the state-led, investment-heavy economic agenda that's at the heart of this characteristically Chinese financial crisis.  His latest industrial policies may aspire to fancier products – robots, microchips, electric cars – but they could create the same old mess: too many factories, too much debt, too much waste.

Even if Xi's approach gives birth to new sectors and growth, that won't necessarily undo the harm already done.  The bad loans won't magically transform into gold.  The only real difference between a regular financial crisis and a financial crisis with Chinese attributes is the duration.  Most normal financial upheavals last months; China's may drag on for years. 

As most of the West is finding out, there's no such thing as a "mixed" economy.  Either you have free markets or you don't.  China will continue to grow – GDP rose 6.5% last year – but for a country that experienced double-digit growth for a decade, it's almost like a recession.

That will come later.  Meanwhile, the Chinese keep "stimulating" the economy with easy credit, and the bad loans are piling up.  No one knows where the breaking point might be, but it's coming.