China’s Great Wall of Debt6 min read

Mike Cormack reviews China’s Great Wall of Debt by Dinny McMahon


Debt has replaced unbalanced growth as the great fear afflicting the Chinese economy. Following the 2008 financial crash, this is understandable: the figures are enormous, and often unparalleled. Between 2007 and 2014, Chinese firms went from owing a total of $3.4 trillion US dollars to $12.4 trillion. Tell-tale signs of financial distress resound, even when muffled by the damper of Party news management. And though the economy keeps on growing by a hefty 6.5% or so a year, the vast surge in debt over the last decade suggests an economic system with deep-rooted problems – from inefficiencies to misallocation of capital and irrational priorities, led more by political constraints than economic imperatives. Deciphering these signals is a tricky game: growth remains substantial (if the data can be trusted, which is also doubtful), and interested parties are working to minimize the impact of market realities as industries decline and fall in the global marketplace. The fog of economic war is thick and hazy.

In his new book China’s Great Wall of Debt, former Wall Street Journal reporter Dinny McMahon dissects the Chinese economy through the prism of debt. It is there that the distortions and stresses of the Chinese economy can best be found – bad debt is the sump of the financial engine, where economic debris and detritus accrue. (Though there is clearly, to extend the metaphor, significant lubrication ongoing). Focusing on this leading stress area to examine the weaknesses of the Chinese economy is smart: it’s what everyone is talking about, and it shows that assuming strong growth will continue forever is for mugs. But in another sense, it’s too easy. Instances of financial stress or corporate misbehavior can be found in every economy, and can be corralled to suggest structural problems. It is crucial to align the anecdotal and circumstantial with the structural and systemic, and to show how such problems have come about.

Does McMahon do this? And what story of Chinese debt does he tell? McMahon’s thesis is that the Chinese economy is far less strong than widely supposed, and that its seemingly inevitable ascent is very far from assured. He investigates where debt is having the greatest impact, and uses that to demonstrate the structural weaknesses he believes are afflicting the Chinese economy. These include: the black box of data (where government and businesses collude to obscure financial information that would inconvenience them, and which therefore deny investors and business partners anything like a fair shake); zombie firms (which don’t make profits but are kept alive through political expediency); ghost cities (built on debt but lacking the numbers to make them viable long-term); land sales and property bubbles; financial products and institutions; asset bubbles created by the welter of easy credit; the famous “vested interests” opposing economic reform; rising protectionism (despite Xi’s Jinping’s attempts to position China as the champion of free trade); and the likely effects of a “new normal” of reduced growth on politics and society. This lengthy list clearly indicates the ambitious range of the book.

pullquote: “Bad debt is the sump of the financial engine, where economic debris and detritus accrue”

Throughout, McMahon raises instances of financial distress. His examples are occasionally familiar (ghost towns have been widely discussed, for example in Tom Miller’s China’s Urban Billion) but still jaw-dropping. A small town called Hanglen, in Guangdong province, was found to be submitting faked statistical data: a quarter of its claimed firms “had stopped production, moved out of town, or ceased to exist”; industrial production data had been overinflated by 400%. Plans for new cities and districts exist that could, if built, accommodate 3.4 billion people, twice China’s total population. Wealth-management products sold by banks in 2016 totaled 29 trillion RMB, or 20% of bank deposits, a twelvefold increase in seven years. And between 2007 and 2015, China was responsible for 63% of all new money created globally.

Systemic issues are also considered. For example, a key difficulty for foreign firms in China is local protectionist policies under the guise of endless local subsidies and bureaucratic barriers. China has, of course, a huge single market, but one where individual provinces have a great deal of sway. Trade barriers “between provinces – and even between counties within provinces – are pervasive and have proved harder to remove than barriers between nations,” writes McMahon. It’s hard to be sure to what degree such matters are a basic inability to enforce law throughout China, or a bad faith connivance with lower administrative levels. Neither situation makes Chinese governance look good.

However McMahon doesn’t always fully establish that these weaknesses are pervasive, and structurally so throughout the Chinese economy. If the goal is to align the anecdotal with the structural, then China’s Great Wall of Debt doesn’t quite succeed. Much is made of specific examples – such as Erzhong, a zombie firm in Sichuan, or the somehow unreformable salt monopoly, which has survived modernization attempts in 2004, 20005, 2007, 2010 and in 2014. (MacMahon’s typical method is to introduce an example at the start of each chapter, tell their story, draw lessons, and then look at how similar problems occur throughout China). These are indeed informative, and probably representative. But they don’t convey a sense of proportion or analytical thoroughness – this albeit being near impossible, given the black box of official and corporate connivance. But you start to wonder what economic success stories might demonstrate.

Likewise, McMahon notes cases where Chinese economic indicators exceed US equivalents with a portentousness that may not be deserved. He records that between 2003 and 2013, Tier one cities saw annual house price growth of 13.1%, while tier two city house prices grew by 10.5% and those in tier three cities grew by 7.9%. “In comparison,” he writes, “in the lead-up to the subprime mortgage crisis, U.S. housing prices grew 7.1% on average annually in the four years prior to the market’s peak.” But correlation is not causation. Lacking alternative investments, and in a country where new urban arrivals number in the millions, Chinese real estate is the best place for anyone to park their money. This of course raises many other problems, such as state firms getting into the sector to seek easy profits, but to compare growth rates between countries with so many differences in economic structure is misleading.

These problems mean that China’s Great Wall of Debt is more of a survey than a structural analysis. It isn’t quite as comprehensive as it wants to be, and the size of its canvas works against it – entire books could be written on its chapter topics. Nonetheless, it is highly readable, with a pleasing variety of approaches, from the shoe-leather reporting with local colour, to interviews with relevant individuals, to analysis of credit growth. It doesn’t compare to The China Conundrum by Yukon Huang, which is for my money the finest book on the Chinese economy in recent years for its depth and rigour, but for anyone wanting to look beyond the conventional wisdom, China’s Great Wall of Debt would a fine place to start. ∎


Dinny McMahon, China’s Great Wall of Debt (Houghton Mifflin Harcourt, March 2018)