We need to talk about China

All good things come to an end. For China, that saying might finally be catching up. Since 1978, the country has defied economic gravity, becoming the world’s growth engine. As Gordon Brown found out, if you think you’ve solved the riddle of boom and bust you’re just storing up trouble. So brace yourself: the wheels seem to be coming off the Chinese economy, and the consequences will ripple far beyond Beijing’s borders.

In 2023, China’s GDP grew by 5.2%—a figure that would be the envy of any developed nation, but for China, it’s sluggish, well below its pre-pandemic trajectory. Worse still, the World Bank forecasts an even slower 4.8% for 2024, signalling that deeper, structural problems are at play, and they’re set to get worse before they improve.

China faces the same headwinds as the wider global economy — sluggish growth, weak international trade, tight monetary policies, and geopolitical flashpoints from the Middle East to Europe. But Beijing has an additional set of self-inflicted wounds: weak domestic demand, a limping property sector, and limited capacity for traditional stimulus measures. It’s a toxic brew.

What’s more troubling is that China’s official numbers, always massaged by state-controlled reporting, may not even tell the full story. Beneath the surface lies a ticking real estate time bomb, a mountain of debt, and creeping social controls—all of which cast long shadows over China’s economic future.

At the core of China’s dilemma is the absence of a meaningful firewall between the state and the economy. The government wields the business world as just another lever of political control. This has worked fairly well in the past. The Chinese Communist Party forced the population to trade personal freedoms for economic prosperity, but the opening of the markets delivered one of the biggest reductions in poverty in history. That deal was predicated on uninterrupted growth. If the engine stalls, Xi Jinping could face an angry and restless populace.

In an attempt to stave off economic collapse, Beijing has been throwing the kitchen sink at the problem. In the wake of the pandemic, the Chinese government launched a series of fiscal stimuli, starting with $450 billion in 2020. By 2023, an additional $110 billion was added, followed by the largest-ever intervention—$1.07 trillion in 2024. These measures aim to prop up infrastructure, keep the stock market afloat, and shore up the struggling property sector. But none of it seems to be working.

China’s debt-to-GDP ratio now exceeds 280%, a figure comparable to Western economies like the UK and US. Yet it’s the structure of this debt that’s particularly worrying. The central government’s debt-to-GDP ratio is a relatively modest 83.6%—low by international standards (the UK sits at 100%, and the US at 120%). But this statistic masks the real danger—soaring local government debt.

By 2023, local government debt in China had ballooned to over $9 trillion, accounting for 45-50% of the country’s GDP. In contrast, local government debt in the US and UK sits at just 15% and 4% of GDP respectively. The difference is stark, but it’s not just the scale that’s troubling. Chinese local governments rely heavily on off-balance-sheet entities, such as Local Government Financing Vehicles (LGFVs), to finance infrastructure projects and service debt. These LGFVs are hard to track, prone to corruption, and largely funded by selling land to housing developers — fuel for China’s overinflated property market.

What this means is that central government has effectively offloaded its fiscal problems onto local government, making the latter dependent on land sales to keep afloat. If (or rather, when) the housing bubble bursts, this vital revenue stream will vanish, pushing heavily indebted local authorities into a fiscal crisis. With limited ways to raise funds, many will be forced to default on the mountains of debt they have accumulated. This isn’t just a local issue—it’s a ticking time bomb for the entire Chinese economy.

Every fiscal stimulus Beijing unveils feels like plugging a leaking dyke. Sooner or later, the dam will burst, and the long-term consequences will be devastating. Even if the Communist Party bureaucrats were to undertake serious structural reforms, which they won’t, it’s probably too late.

The property market is the canary in the coal mine for any economy. For decades, China’s real estate sector was the pillar of its economic boom, accounting for almost 30% of its GDP—a staggering figure when compared to the US, where real estate peaked at 18% before the 2008 crash. And now that Chinese pillar of growth is crumbling.

Take Evergrande, one of China’s largest developers, which went bust this year with liabilities exceeding $300 billion. To put that in perspective, Boeing—currently a topic of international business scrutiny—has liabilities and shareholders’ equity of around $130 billion. When Lehman Brothers collapsed in 2008, triggering the biggest financial crisis since 1929, its liabilities stood at $613 billion. But Lehman was a bank. Evergrande is a property developer and a liability of $300 billion is enough to bring down numerous Lehmans. Evergrande was a housing behemoth.

Yet, despite Evergrande’s failure, the full-scale crisis many expected hasn’t materialised—yet. The Chinese government stepped in, restructuring the company’s debts and managing the collapse. In a free market, such an implosion would have reverberated through the banking sector, potentially triggering a Lehman-style crisis. But in China’s state-controlled system, the damage has been contained. However, other over-leveraged developers are teetering on the edge, and the broader property market remains on the brink of collapse. There just isn’t enough money in the world for the Chinese Communist Party to keep papering over the cracks.

The Evergrande saga has been unfolding since 2021, when it first missed a bond interest payment. Had China allowed the market to take the hit then, it might have been a manageable crisis, a storm in a teacup. But Beijing’s instinct to avoid even small disruptions has simply stored up trouble. Now, China finds itself chucking good money after bad, delaying the inevitable. A full-scale meltdown in the Chinese property market could dwarf the 2008 financial crisis, and the fallout would engulf not just financial institutions but wipe out local governments and millions of homeowners.

A deep recession in China wouldn’t stay within its borders. Countries in Asia and Africa, whose economies rely on China’s insatiable demand for raw materials, would be hit hard. A sharp drop in Chinese demand could push these nations into recession. Western markets, too, would be shaken, particularly in sectors exposed to China’s real estate and infrastructure spending. Western financial institutions have eagerly ridden the wave of China’s growth—part of your pension is likely invested in it.

But the biggest wildcard is China’s vast reserves of US dollars. Officially, China holds over $3 trillion in reserves, with estimates suggesting another $3 trillion in “shadow reserves”. If China released these dollars to prop up its domestic economy, the result could be global financial chaos. It would devalue the dollar and trigger a deflationary spiral—an economic nightmare. As any student of German history knows, it was deflation, not inflation, that brought down the Weimar Republic.

I’m not saying such a deflation is inevitable, but the risks are real. China’s future is increasingly uncertain. Its addiction to debt, a crumbling property market, and growing geopolitical isolation are creating a perfect storm. Without serious reforms, China could face an economic collapse that would send shockwaves across the globe, reshaping the financial landscape for decades to come.

The West, meanwhile, cannot afford to be complacent. We need to prepare for a potential Chinese collapse. The storm might still be gathering, but when it hits, it will be a storm of historic proportions.

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