China facing a double bust?

Since the abandonment of collectivism Chinese governments have done well to boost their economy and prosperity in a remarkably few years but are they now putting all that at risk through tightening political control and ever-more reliance on horrifically high debt levels? Potentially worse still, is the strength and size of the economy being used to cow much smaller nations as China, for instance, illegally lays claim to 'islands' it has developed and militarised from shoals and reefs in the South China Sea, up to 600 miles from its shores?

China's development has come at a big social cost, from an environmental disaster that kills over one million citizens every year, mainly through air pollution, to a hardening of central government repression as the people agitate for fairer rights and conditions, a process the government sees as squeezing the party out of leadership at the local level and therefore becoming a serious form of political opposition. One former Chinese government official, who has left the country, sensibly remarked: "I don't understand why the government doesn't let the people vent the way it used to. It relieves some of the pressures and you can see where the grievances are."

One reason why the Chinese government is tightening its grip by cracking down hard on legitimate dissent and free expression is the slowing economy -- a trend that current government economic policies seem wrong-headed or ambiguous to head off, though there are some glimmers of hope here. Chinese governments have repeatedly promised that they would keep a lid on borrowing and implement reforms. But the latest data suggests that government-owned banks are lending more, not less.

Cheap credit has played a key role in boosting GDP by 6.7% in the latest quarter to June from a year earlier but the result of all this debt bingeing is that government debt is now 2.5 times GDP and consumer and corporate debt at all-time problems highs. In June alone total lending soared US$244 billion but the problem is that many of the loans are going to unprofitable state-owned enterprises (SOEs) kept alive only to avoid heavy job losses. It would make sense instead to lend the money to private companies to expand their hiring. But the government knows it must, as promised, shift the economy from manufacturing towards services and consumption and that means slashing industrial overcapacity by closing inefficient SOEs and so initially raise unemployment -- a reason, perhaps, for its more repressive regime buttressed by the strengthening of the People's Liberation Army because it sees potential trouble ahead. The risk is that if the regime feels threatened by home-grown problems it will try to deflect them through nationalism and the most likely flash point is in the South China Sea.

This excessive debt has been described as China's "original" sin, which has led to some ratings agencies to warn that the banking system may need $500 billion more in capital to offset rising bad loans. Despite some bright spots in the economy and the authorities making some right moves, long-term growth prospects have hardly improved as risks continue to rise. The risk of an economic and social bust, therefore, is considerable.
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