Book review

China's Great Wall of Debt by Dinny McMahon

Title:  China’s Great Wall of Debt: Shadow Banks, Ghost Cities, Massive Loans, and the End of the Chinese Miracle

Author: Dinny McMahon

Publisher:  Houghton Mifflin Harcourt

China’s finance ministry announced in May that provincial and municipal governments would be allowed to issue 15-year and 20-year bonds for the first time, instead of the usual three-year or shorter maturities. This would enable officials to once again put off repayment of the trillions of yuan owed by China’s local government. 

For all China’s economic success, local-government debt hangs around the country’s neck like a millstone. In 2016, American investment banker Jim Chanos called China’s debts a “treadmill to hell,” while Forbes refers to it as a “time bomb.” 

The amount is vast: the last official audit in 2014 calculated the total at 15.4 trillion yuan (US$2.42 trillion). The Financial Stability Board, the global watchdog, estimated that China’s municipal debts had ballooned to the equivalent of more than US$7 trillion by the end of 2017. 

To Dinny McMahon, a former foreign correspondent in China, the debt is a near-impenetrable barrier to progress. His new book, China’s Great Wall of Debt: Shadow Banks, Ghost Cities, Massive Loans, and the End of the Chinese Miracle, paints a grim picture of the dark side of easy credit amid political posturing and financial short-termism. 

A Mandarin-speaking, long-time China watcher who wrote for The Wall Street Journal, McMahon is admiring of China’s economic success. The country grew, he notes, because the authorities developed a long-term vision and invested in the future, such as industrial infrastructure, housing and public works. 

However, once consumed by the idea of growth, China couldn’t stop. “A common misconception about the Chinese economy is that it’s driven by exports,” McMahon writes. “That was once the case, but it hasn’t been that way for more than a decade. When the global financial crisis hit, the ever-increasing volume of exports… was brought to a shuddering halt.” 

To take up the slack, Beijing – like other major economies – launched a massive economic stimulus through its banks. Now excessive investment is dragging on the economy because it is funded by debt. A crisis is inevitable, McMahon writes. “China’s authorities have an unparalleled capacity to kick the can down the road. But with every kick, the can gets bigger and doesn’t go as far. At some point, it will go no farther.” 

McMahon is far from the first writer to observe China’s mounting debt problem, especially as it reached 260 percent of gross domestic product by 2016. But despite many predictions – from billionaire investor George Soros down – the inevitable hard landing has so far failed to materialize. 

In the book, China doesn’t experience a sudden meltdown. McMahon notes “Beijing has deliberately… insulated China’s financial system from the rest of the world, such that problems in China are unlikely to result in international financial contagion.” Instead, as economic demand begins to contract, China would buy fewer things from overseas, hitting major trading partners, such as the United States, Japan, South Korea and Australia, and other countries that rely heavily on China for trade. 

The author sets out the trajectory of China’s strong economic growth, and leavens the macroeconomics with corporate anecdotes and a cast of characters from high officialdom to the factory floor, whose observations on the state of China’s economy range from trenchant to tragic. Zombie companies, government meddling and outdated factories are taken to task. 

McMahon is pessimistic about what many other authors see as bright spots in the economy, such as China’s technology giants, or the Belt and Road Initiative. “Neither is likely to have a material impact on the trajectory of China’s economy.” However, McMahon does explain actions Chinese regulators have taken: reducing leverage, improving transparency and strengthening risk management. 

Yet China’s government must accept much of the responsibility for the present situation. “Villages lie to townships, townships lie to counties, and so on all the way up to the State Council,” McMahon writes. Local government leaders have long been rewarded for growth, even when they prioritize tax contributions and projects above prudent management and planning. 

To be sure, most debt is in local currency and thus China is less vulnerable to external pressure than Turkey, Indonesia or Argentina, which rely on foreign debt. But the implicit government guarantee behind the new bonds announced in May suggests that there has been no reform of the mentality that the state remains the ultimate bailout machine. For how long?

Author interview: Dinny McMahon

To Dinny McMahon, China’s debt is at the heart of the country’s problems. “It’s symptomatic of an economic model that’s no longer sustainable [and it’s] representative of a system of governance that has growing increasingly unaccountable.”

The former correspondent for The Wall Street Journal warns that the debt threatens to destabilize both the economy and financial system if not handled properly. “Having spent years covering China’s financial system, I saw it as the starting point to explain the mechanics of how the Chinese economy really works, and how it differs from global perceptions.”

McMahon was born and raised in Australia, a country that perceives the Chinese economy far differently than the United States. “In my early days, it certainly imbued me with a degree of optimism about China’s ascent that was less evident in friends and colleagues from the U.S.,” he tells A Plus from his current home in Chicago, where he is a fellow at MacroPolo, an economic think-tank.

“Whereas Americans of my generation typically grew up on a diet of stories about Chinese human rights abuses and lost manufacturing jobs, in Australia, China had been a major contributor to decades of rising prosperity,” he says. The economic problems described in Chinas Great Wall of Debt have been greeted with a degree of schadenfreude in the U.S., he adds. “As an Australian the underlying dysfunction I’ve witnessed in the Chinese economy has always been a cause for alarm.”

McMahon has been keenly watching the trade tensions play out between China and the U.S. “I think the most likely outcome is that the U.S. will settle for some sort of managed trade arrangement whereby China agrees to buy more U.S. goods without changing the way its economy operates.”

“The problem is that while such an arrangement might end the ‘trade war,’ trade tensions are going to be with us for years to come, particularly if managed trade results in China diverting imports from other countries in order to satisfy U.S. demands,” he adds.

As a journalist, McMahon sees the Chinese business media enjoying relatively more freedom than most other areas of reporting. “The local press routinely produces reporting that surprises me in terms of its depth and its willingness to operate close to the limits of what is politically acceptable,” he says. “But the real value of the Chinese business press isn’t its scoops but its everyday reporting on government regulations and the impact they’re having on the ground.”

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