My favorite analyst of bubble economies is David M. Smick, who predicted the U.S. financial mess in his book "The World Is Curved." He notes some worrying statistics: Until the global financial crisis, Chinese exports represented 43 percent of its gross domestic product. To make up for collapsing foreign demand once the recession hit in 2009, China launched a $1.8 trillion stimulus and lending program -- amounting to about 38 percent of its GDP. This money was supposed to reach consumers, but Smick estimates that 85 percent of the subsidized loans went to state-run companies and banks -- pumping the investment bubble even larger.
Not to worry, say China enthusiasts: A country with more than $2 trillion in foreign reserves doesn't have to worry about debt problems. But those reserves (mostly in dollars) aren't quite the safety net some imagine, because China couldn't liquidate them without hurting itself badly, as economist Michael Pettis argues in his blog, China Financial Markets.
China has a larger problem of questionable loans on its domestic balance sheet. Smick notes that $1.2 trillion of the Chinese stimulus package last year came in soft, subsidized loans. And Victor Shih, a professor at Northwestern University, has been gathering information about murky, off-books borrowing by local investment companies that he reckons could amount to as much as $1.7 trillion, or about 34 percent of China's GDP.
The most reassuring fact about China is that the country's leaders see the problem and are trying to put on the brakes, ever so gently. For a reminder of the dimensions of the overcapacity problem they're facing, consider that China has enough steel-making capacity to meet the demands of the United States, Russia, Japan and Europe combined.
For a country addicted to export-led growth, transitioning to a sustainable economy won't be easy. People who assume that an ever-expanding China will inexorably replace America as the world economic superpower should take a close look at the numbers.
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