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For most of the past 10 to 15 years, China’s economy has followed a familiar pattern of boom and bust, even though official GDP data was oddly flat.

Central government authorities would flood the market with fiscal and monetary stimulus until activity starts to get too hot, and then tighten the currency. The authorities engaged in this financial engineering to drive economic growth to high target levels while still trying to smooth the risks in both directions. With an economy even with official data barely growing and the market anticipating a boost, why isn’t China stimulating?

Even based strictly on official data, China’s economy is facing perhaps its toughest time this century. Local government revenues are collapsing, with public revenue drops of more than 20-40% in some places. Banks have been best at protests withholding deposits and mortgage holders refusing to pay. As developers grab the headlines, companies across China are facing deep challenges paying off debt due to over-leveraged balance sheets and business shutdowns due to the COVID-19 pandemic. So why hasn’t China pumped money into the system to stimulate growth?

People hold banners and chant slogans during a protest at the entrance of a branch of China’s central bank in Zhengzhou, central China’s Henan Province, July 10, 2022. (Yang /AP Photo)

Unfortunately, we just don’t know. Regulators say all the right things about not stimulating, but they’ve said the same thing before and have always stimulated the economy, increasing debt over the years to mind-boggling levels. It is possible that Chinese Communist Party (CCP) policymakers have changed their minds, becoming fiscal conservatives and refusing to stoke the fires of moral hazard for fear of exerting undue pressure to bail out state-owned banks. However, from regulators to banking, these are largely the same people who have been in charge for the past decade. So unless readings of Milton Friedman are surreptitiously circulating, such a profound shift in regulatory philosophy seems unlikely.

Chinese leader Xi Jinping has prioritized greater adherence to the central Party leadership and socialist revival. Is it possible that his policies of restricting bankers’ salaries, targeting corruption and limiting the growth of debt are finally paying off? It is possible but an unsatisfactory answer. We are in the last year of his second term, and all of these policies have been championed by Xi for years. So why are the policies changing only now?

Is it possible that politics is undermining the Chinese economy? With Xi set to be re-elected for a third term, there are credible reports of backsliding against Xi’s agenda. Choking off funding that has boosted China’s economic growth since 2008 would be a way to weaken Xi in an election year when the CCP typically floods the economy with stimulus. However, this seems problematic because, given the nationwide problems, it would take some degree of cooperation between many institutions to challenge Xi.

Epoch Times Photo
China’s five largest state-owned banks are facing worsening bad debts. (Getty Images)

None of these possibilities seems satisfactory. There is one last possibility, but a very worrying one. What if China ran out of money?

Banks are withholding deposits or limiting withdrawals and capital levels, even using official data, and scraping the depths of regulatory minimums, around 8%. This means that even if the government wanted to engage in a major stimulus, there is little evidence that China’s financial sector has the capital to absorb a rapid increase in public debt. Chinese households do not have the capacity either, given their high level of indebtedness which now exceeds most of the OECD countries.

This means that the only source capable of buying government or corporate bonds on the scale needed to absorb a large Chinese stimulus package would be the People’s Bank of China. This would cause major problems and force the PBOC to fund the stimulus. Given the absence of broad demand for additional credit from businesses or households, there are also problems on the demand side. In other words, banks lack the capital available to absorb large credit issues, and no one except the central government seems eager to take on new debt given the large surplus.

This presents problems for China, given its debt-fueled model of economic growth. If growth drops significantly, this will present a major risk to repayment. However, if they don’t issue new debt, growth will plummet, creating a death spiral.

When the Japanese economy went through a similar period in the late 1980s, asset prices remained flat for 30 years despite 30 years of stimulus and zero interest rates. China now hopes for this outcome and not something worse.

The opinions expressed in this article are the opinions of the author and do not necessarily reflect the opinions of The Epoch Times.

Christopher Bald

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Christopher Balding was a professor at Fulbright University Vietnam and HSBC Business School at Peking University Graduate School. He specializes in the Chinese economy, financial markets and technology. A senior researcher at the Henry Jackson Society, he lived in China and Vietnam for over a decade before moving to the United States.