Rising debt levels and an unsustainable economic model leave Beijing at Washington’s mercy.
The Chinese Communist Party has always relied on deception to wrong-foot rivals and attain the advantage in negotiations. Deng Xiaoping famously counseled, “Hide your strength, bide your time.” But Xi Jinping prefers to exaggerate China’s economic strengths and conceal its vulnerabilities.
Mr. Xi’s brazen approach conditions other countries to believe that Beijing enjoys a superior hand, that China’s rise and dominance are inevitable. These erroneous beliefs weaken the will of injured parties, including Western nations, to resist predatory Chinese behavior.
President Trump and Mr. Xi confirmed a “phase 1” trade agreement Friday. Both need the deal for domestic political and economic reasons. But in every negotiation, pressure is relative, and the U.S. has more political and economic leverage than China. This insight will help the U.S. during the more difficult second phase of negotiations.
Consider why China engages in predatory, illegal economic behavior. It needs to grow rapidly to maintain fiscal stability, manage its debt and advance its strategic and military ambitions.China can’t become the dominant power in the Indo-Pacific without sustained growth. The only reliable way Beijing has of maintaining adequate growth is to support its companies with cheap credit. The rise in Chinese corporate debt since the 2008-09 financial crisis has been one of the largest and most rapid—in relative and absolute terms—for any 10-year period in peacetime economic history.
China cannot significantly deleverage without drastic changes to its political economy. The model involves offering state-owned enterprises and national champions such as Huawei cheap finance and privileged domestic-market access at the expense of an independent private sector. China showers state businesses with subsidies and stolen intellectual property, and shields them from foreign competition.
The Chinese domestic economy is slowing because of chronic overinvestment. This provides the economic rationale behind plans such as the Belt and Road Initiative and Made in China 2025. The former is a scheme to export excess capacity and lock in new regional markets for Chinese firms, especially in infrastructure. The latter is a new export-oriented approach based on dominating increasingly important advanced and high-technology sectors in global markets. Both attempt to create external commercial opportunities for protected, unreformed Chinese firms without the need to reform the country’s main economic and political institutions.
Mr. Xi believes doubling down on this approach offers the party the best prospect to retain its hold on power and opportunity. As with virtually all major economic developments in China, the party soaks up praise when things go well and wears blame when they don’t. As Chairman of Everything, Mr. Xi faces acute pressure. His success depends on preventing the emergence of a genuinely independent middle class, which is what led to democratic transitions in Japan, South Korea and Taiwan.
That brings us to the question of negotiating leverage.
The current Chinese model is self-defeating. Less-deserving companies continue to receive the bulk of finance and opportunity. The staggering misallocation of capital is worsening, which makes the mushrooming debt even harder to manage. And allocation of opportunity is political. This means that the private sector, and therefore household income, will continue to remain artificially suppressed—putting even more pressure on Beijing to stimulate growth through further credit expansion.
The U.S. has a far more adaptive and diverse economy than China. China’s economy is inefficient, bloated, dysfunctional—plagued by institutions and policies that are not fit for their purposes. If the tariff war resumes, it will continue to prove much more disruptive to China than to the U.S.
Moreover, by calling attention to the seriousness of Chinese trade violations, Mr. Trump is properly recasting China as the main threat to a fair and sustainable global economic system. Multinational companies are gradually assessing the commercial risk that sovereign risk poses to them—the possibility that China will arbitrarily alter laws or regulations or fail to honor government bonds when they mature.
In recent years, Mr. Xi has been openly accused by former senior officials and influential journalists and academics of mismanaging the relationship with America, decisively abandoning any market-based reforms that would make the Chinese economy more resilient and agile, and overreaching with his aggressive promotion of Belt and Road and Made in China 2025. Leaks about the abhorrent treatment of Uighurs in Xinjiang seem designed to undermine him, while continued protests in Hong Kong are a stark rejection of his authoritarianism.
Mr. Xi’s purging of more than 1.5 million officials, including top generals and party members, will come back to bite him. In addition to holding a weaker economic hand, Mr. Xi is far more vulnerable to internal rebellion, and therefore more desperate for economic pain relief, than the American president.
Mr. Trump has threatened to walk away if any agreement—including the final details of the phase 1 deal—is not to his liking. He indicated in “The Art of the Deal” that his style is to aim high and keep pushing and pushing until he gets what he wants. Let’s hope he follows through. The national interest depends on it.
Chinese under 30 aren’t savers like previous generations. That’s helping diversify the economy, but adding to household debt
Western economists have long said that China needed a base of American-style consumers to bring the country sustained economic growth. Now China has one: Its young people.
While previous generations were frugal savers—a product of their years growing up in a turbulent economy with a weak social safety net—the more than 330 million people born in China between 1990 and 2009 behave much more like Americans, spending avidly on gadgets, entertainment and travel.
The freewheeling consumption is helping China diversify its economy at a crucial time. Beijing has relied on exports and infrastructure-building to drive growth for decades, but recent signs point to a slowdown amid tariffs from the Trump administration. The new spending patterns have benefited Alibaba Group HoldingLtd. ,Tencent HoldingsLtd. and other tech companies, whose rapid growth has helped energize China’s economy.
Yet all this consumption has a downside. Household debt levels have risen rapidly over the past several years, with many young Chinese borrowing money for their purchases.
High levels of corporate and government debt are already longstanding concerns for Beijing. As household debt climbs, some economists worry the country’s debt burdens overall could become unmanageable and weigh on China’s growth.
Yang Huixuan, 22, who graduated from college this year, has turned to online loans to pay for meals out, cosmetics and clothes.
To avoid problems down the road, some economists say, household borrowing will have to slow to more sustainable levels, adding another headwind to China’s economy. In a worst-case scenario, they say, the combination of high government, corporate and consumer debt could exacerbate the economic slowdown and trigger a broader loss of confidence in China.
Liu Biting, 25 years old, says she spends all of her paycheck each month: 10,000 yuan ($1,400) a month from her marketing job in Shanghai. About a third goes to rent, and the rest on food, her sewing hobby, going out, music and other products. So far, she has avoided falling into debt.
Until recently, one of her monthly expenses was a clothing rental subscription that cost $70 a month. She liked it, she says, because she could “try out a lot of strange clothes.” She discovers makeup brands on a WeChat account she follows that recommends products, many of them local.
“For my parents’ generation, for them to get a decent job, a stable job, is good enough—and what they do is they save money, they buy houses and they raise kids,” she says. “We see money as a thing to be spent.”
Her parents repeatedly ask her how much she has saved in her three years of working. “I say, ‘I’m sorry, probably nothing.’ All my friends are like this. We have no savings and we don’t really care about it.”
Liu Biting shopping in Shanghai.
Young people have “become the main consumption power” in China, Alibaba chief executive Daniel Zhang told reporters in November. People born after 1990 made up nearly half the customers during the latest “Singles Day” annual shopping event, when Alibaba sold roughly $30.8 billion of merchandise in 24 hours.
New GenerationsChina’s population by age groupSource: National Bureau of StatisticsNote: From the 2010 Population Census, most recentyear available.
Under 1010-1920-2930-3940-4950-5960-6970-7980-8990 and older0 million100200
Almost a quarter of car buyers in China are under 30, and that figure is expected to rise to roughly 60% by 2025, says Zhou Ya, head of market research and customer intelligence for Volkswagen GroupChina. She says Volkswagen sees Chinese customers under 30 as crucial to its future in the country. The company is rolling out three entry-level models geared toward young drivers in China’s less developed cities this quarter.
Chinese youths are especially more willing to pay for travel. A report last year by Mastercard and Ctrip.com, China’s biggest online travel website, found that about one-third of China’s outbound tourists who booked with Ctrip were born after 1990, and they spend more on a single trip than those born in the 1980s.
Short-term loans from online lenders such as Ant Financial Services Group are helping fuel the spending. Ant Financial charges rates up to nearly 16% on an annualized basis, depending on the credit profile of the borrower. A 2018 survey in China by Rong360, a loan recommendation website, found that around half of respondents who took out consumer loans were born after 1990.
Wang Xinyu, 24, has racked up about $11,200 in debt spread over six credit cards.
Most had borrowed from multiple lending platforms, the survey found, and nearly a third took out short-term loans to repay other debts. Nearly half of them had missed payments.
One of the most popular ways to borrow is a Huabei account, a revolving credit line embedded in China’s Alipay mobile payments network. Huabei has extended loans in excess of 1 trillion yuan, or more than $140 billion, since its launch in April 2015, a person familiar with the matter said. Ant Financial, which owns Alipay, declined to disclose any figures related to Huabei.
Going MobilePercentage of users of mobile payments inChina by ageSource: Payment & Clearing Association of China
54.42%27.613.8521-3031-4041-5051 and older
China’s former central banker Zhou Xiaochuan warned last November that the rise of fintech, while helping develop the consumer credit market, may “excessively induce” the younger generation to spend beyond its means.
Yang Huixuan, 22, who graduated from college this year and works in communications for a soccer club in Nanjing, says she turned to Huabei while in school. She says she often borrowed around $100 a month to pay for meals out, cosmetics and clothes that she couldn’t cover with the roughly $215 stipend she got every month from her parents. She relied on Huabei’s installment payment function to afford bigger items like cameras and smartphones.
Huabei is “truly addictive,” says Ms. Yang, “It gives me an illusion that I’m not really spending my own money.” Ms. Yang says she’s scaling back some now because of higher living costs and because she’s reluctant to keep turning to her father for money.
Yang Huixuan shopping on her phone in her dorm room in Nanjing and looking for deliveries in the mail room.
An Ant spokesman says Huabei encourages its users to spend responsibly, and gives users the option to set monthly limits to help monitor their own spending.
Easy credit has come from a wave of online micro-lenders and peer-to-peer lenders, which proliferated several years ago amid loose regulations. Some charged exorbitantly high interest rates.
Authorities have halted issuing licenses to new online lenders since late 2017, and tightened oversight to ensure interest rates on some loans are capped at an annual percentage rate of 36%. As of July, fewer than 800 peer-to-peer lenders remained in operation, from more than 2,600 in early 2016, according to industry website wdzj.com.
Borrowing BingeShort-term borrowing makes up a rising proportion of household debt in China.Source: WindNote: 1 trillion yuan = $140 billion
.trillion yuanShort-term loans forbusiness purposesMortgages, auto loansand other longer-termdebtShort-term consumerloans2004’06’08’10’12’14’16’1801020304050
The average consumer spending of Chinese credit-card holders between ages 21 and 30 in 2016 was around $8,820, 39% higher than their average credit line of $6,360, according to data from Oliver Wyman, a New York-based consulting firm. Consumers can spend more than their credit limits by taking out additional loans from other channels, such as online lenders, or with subsidies from family.
Wang Xinyu, 24, says he has about $11,200 in debt spread over six credit cards, much of it accrued when he was in college and found it easy to swipe cards to pay for everyday expenses.
Mr. Wang, who earns about $600 a month working at a Beijing bookstore, says he now puts his entire salary toward paying down his debt. He still relies on credit cards to pay for food and rent, and sometimes uses one credit card to pay back another.
Wang Xinyu at work and shopping for groceries in Beijing.
Young people in China are being “pushed by the tide of the era” in their reliance on easy credit to pay for things, he says.
JPMorgan estimates China’s ratio of household debt to gross domestic product will climb to 61% by 2020. That’s up from 26% in 2010 and higher than current levels in Italy and Greece.
The level in the U.S. is about 76%, after falling from 98% in 2006, according to the International Monetary Fund.
By another measure—the ratio of household debt to disposable income—China appears to have already surpassed the U.S. Its ratio reached 117.2% in 2018, up from 42.7% in 2008, according to calculations by Lei Ning, a researcher at the Institute for Advanced Research at Shanghai University of Finance and Economics. The U.S. peaked at 135% in 2007 and dropped to 101% in 2018.
On Loan
China has passed the U.S. in one measure of debt, and is catching up in another.
Household debt to disposable income
Household debt to gross domestic product
125
%
125
%
U.S.
100
100
U.S.
75
75
China
50
50
China
25
25
0
0
2008
’09
’10
’11
’12
’13
’14
’15
’16
’17
’18
2008
’09
’10
’11
’12
’13
’14
’15
’16
’17
Sources: Institute for Advanced Research, Shanghai University of Finance and Economics (disposable income); International Monetary Fund (GDP)
Some economists remain unconcerned by the rise in household debt, noting that default rates with consumer loans appear relatively low.
One fear, others say, is that China’s slowdown could be exacerbated if young Chinese lose their jobs or see their wages cut, and have to sharply curtail spending. If they don’t and continue falling into further debt, they could become even more vulnerable in future years.
As the U.S. saw in the 2008 financial crisis, default rates can shoot up rapidly when growth slows.
This generation “has no idea what a rainy day feels like,” said Dong Tao, an economist at Credit Suisse in Hong Kong. “Any consumer credit boom will always be tested—no exception,” he says.
He points to mortgage debt as a deepening problem across China’s economy, including for young people. Mortgage debt outstanding grew from $1.1 trillion in the fourth quarter of 2012 to $3.9 trillion as of June.
Mortgages accounted for about a third of China’s medium- to long-term loans, up from 20% in 2012, according to the People’s Bank of China.
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Parents often help young Chinese to buy a home, which Mr. Tao sees as a danger, with multiple generations now required to afford a single property. A similar phenomenon occurred in Japan in the 1980s, he says, sometimes with three generations helping to pay for a mortgage—a sign the market was overheated. Japan’s economy eventually entered a protracted slowdown as equity and real-estate asset prices corrected.
China’s slowing job growth adds to the challenge. This year, more than 8.3 million college students are expected to graduate, compared with around six million a decade ago and only 165,000 in 1978. Yet some of China’s most desirable employers, like e-commerce company JD.com Inc., have cut jobs as growth ebbs. Last year, a record 2.9 million individuals took the entrance exam for graduate school.
Lu Yu shopping in Suzhou and pointing to his apartment.
Lu Yu, a 26-year-old who works in human resources for the German technology company Robert Bosch GmbH in Shanghai, says he feels more economic pressure now, including a need to help care for his parents. He is living with them at home while an apartment he recently bought—with his parents’ help—is undergoing renovations.
Still, he says he “can’t do mundane jobs that require me to follow the rules” and would like to keep spending on products “that help improve my living environment, like high-quality towels and aromatherapy products.” While his parents are reluctant to spend on fine dining and travel, he aims to travel twice a year, including recent trips to Japan, Cambodia and Thailand.
“For me, if the money isn’t spent on enriching your spirit and bringing you happiness, then what’s the point? Are we supposed to live so that we can save money?”
Although the current poor state of Sino-American relations may make even a very limited currency détente unattainable, such a pact is not outside the realm of possibility. Ultimately, both America and China might see some advantage in taking currency conflict off the table, in the hope of preventing wider damage to themselves and others.
SANTA BARBARA – China’s currency, the renminbi, weakened slightly against the dollar at the start of this week. Around the world, the immediate response was panic. Financial markets tumbled, US President Donald Trump’s administration formally labeled China a currency manipulator, and fears of a new currency war spread like wildfire. To describe all this as an overreaction would be a gross understatement. A currency war has not erupted – at least, not yet.
But the danger is real. Although markets now appear to be recovering somewhat, America and China remain locked in a perilous trade war with no end in sight. The United States is still poised to impose a 10% tariff on some $300 billion worth of Chinese imports. It does not seem unreasonable to suppose that China might then retaliate by engineering a substantial devaluation of its currency. After all, a cheaper renminbi would go a long way toward offsetting the impact of Trump’s tariffs on the prices of Chinese goods in the US.
But, because devaluation would also carry significant risks for China, the country’s leaders will be hesitant to take this step. Many of China’s biggest enterprises have borrowed heavily in dollars, and a weaker renminbi would greatly increase the cost of servicing this external debt. Worse, the prospect of devaluation could spark massive capital flight from China as anxious companies and individuals seek to protect the value of their assets. That is what happened four years ago when the renminbi was allowed to weaken significantly, and the Chinese authorities subsequently had to spend $1 trillion in foreign-exchange reserves to prevent the currency from crashing.
It seems unlikely, therefore, that China is about to declare all-out currency war. What happened earlier this week was much subtler – in effect, a shot across America’s bow. The renminbi was already close to the symbolic level of CN¥7 per US dollar. By setting their daily benchmark rate for the currency at a smidgen below CN¥7, the Chinese authorities created room for currency traders to push the market rate temporarily above CN¥7 – an effective devaluation. Although the actual size of the devaluation was minuscule, the psychological impact was enormous. China was reminding America that it still has many economic arrows in its quiver.
Unfortunately, the Trump administration responded in typical blunderbuss fashion, mistaking the modest Chinese signal for something more sinister. By immediately declaring China a currency manipulator, the US succeeded only in hardening positions on both sides.
To avoid losing face, Chinese leaders may now feel compelled to respond in kind. They could make good on the threat of devaluation, or pull out some of its other arrows. For example, China could
embargo exports of the rare earth minerals that are so vital to America’s tech industry, or prolong its
boycott of US agricultural products. Or it could go beyond the realm of commerce and
stir up trouble in the South China Sea or the Taiwan Strait. In short, relations between the world’s two largest economies could go from bad to much worse.
Can further escalation be avoided? One way to avoid that outcome might be to look to a neutral arbiter to adjudicate the currency issue. The most obvious candidate is the International Monetary Fund, one of whose main functions is to oversee the “rules of the game” in international monetary affairs. All Fund members have pledged to avoid exchange-rate manipulation, and all are formally subject to “firm” Fund surveillance of their currency policies. In principle, if America and China truly want to avoid a monetary conflict, they could ask the IMF to step in to settle matters.
In practice, however, the Fund’s authority is sadly limited. The IMF has no powers to enforce rulings. At best, all it can do is “name and shame” currency manipulators. And in the end, it is hard to imagine either America or China kowtowing to a toothless multilateral organization. Can anyone really picture Trump submitting to the judgment of a bunch of unaccountable international civil servants?
A slightly more realistic option might be a direct bargain between the US and Chinese governments – perhaps also including the European Central Bank and one or two other monetary powers – to achieve some form of currency détente.
There is precedent for such a deal. Back in 1936, following more than a half-decade of uncontrolled competitive devaluations during the Great vDepression, the main financial powers of the day – the US, Britain, and France – agreed to an informal arrangement for mutual exchange-rate stabilization. Jokingly called the “twenty-four-hour gold standard,” the Tripartite Agreement committed each country to give 24 hours’ notice of any change in its currency’s price. Though far from perfect, the pact did manage to restore some semblance of order to monetary affairs.
A similar agreement today would be more difficult to negotiate. In the 1930s, America, Britain, and France were on reasonably good terms. Present-day America and China, by contrast, are strategic adversaries engaged in a trade war, and even a very limited exchange-rate initiative might prove unattainable. Yet it is not outside the realm of possibility. Ultimately, both sides might see some advantage in taking currency conflict off the table, in the hope of preventing wider damage to themselves and others.
