The market will not solve China's oversized debt issue. Though Beijing has taken steps to liberalize its economy in recent years, most roads still lead to the state. It is no coincidence that the bulk of China's debt is owed by state-owned companies to state-owned banks. Aware of this reality, Beijing might be tempted to return to the age-old method of throwing money at the problem. But there are pitfalls in taking this path, too.
For example, the real remedy to China's financial troubles in 1999 was the surge in global demand that fueled double-digit growth, not public funds. Today's problems also exist on a much larger scale. China's GDP amounted to $1 trillion in 1999; now it is 10 times bigger, while the country's debt is nearly 20 times bigger.
Of course, not all of China's debt has to be settled. Most of its loans are still healthy. If Beijing wanted to, it could borrow the funds to recapitalize its banks. At first glance, China's public debt is a manageable 44 percent of GDP, which would allow some room for growth. But if local governments were factored into China's official debt-to-GDP ratios, its public debt would be closer to 90 percent of GDP, placing it up near developed countries in terms of indebtedness and limiting its room to maneuver.
In theory, China could try to inflate away its debt by printing more money. But that would simply shift the burden onto Chinese citizens, a move that would be deeply unpopular at home and abroad. It would also undermine China's own effort to shift its economy toward one based on consumption by eroding the public's purchasing power and weakening the yuan.
There are no easy answers to China's debt problem. The only painless escape would be a wave of economic growth, but at this point that seems unlikely. Achieving growth rates of more than 10 percent is much more difficult for an economy that is already the second largest in the world, and the global economic environment is not half as favorable to China as it was 15 years ago because the developed world is struggling to manage debt problems of its own. At home, Chinese wages are considerably higher, and the economy is less competitive. Because China's working-age population will soon begin shrinking, these wage hikes will make it harder for the country to achieve prodigious growth. Instead, Beijing appears to be on the verge of making a difficult choice: Sacrifice growth (and by extension, political support) to tackle Chinese debt head-on or risk suffering a debt-driven banking crisis.
