BORROWED TIME:

In September 2008, when Chinese President Hu Jintao got word that Lehman Brothers, then the fourth-largest U.S. investment bank, was on the verge of bankruptcy, he was traveling by van along the bumpy roads of Shaanxi Province. Surrounded by policy advisers and members of the Politburo, Hu asked them how China should respond to the inevitable spillover. According to one participant in the discussion, the group reached a clear consensus by the trip's end: China would need to launch a massive stimulus program. And it could trust only state-owned enterprises (SOEs), rather than private firms, to carry it out.

That November, as other governments were still debating what to do next, Beijing announced that it would distribute nearly $600 billion in stimulus funds to SOEs and other institutions, principally to fund ambitious infrastructure and industrial projects. Banks began lending generously, and local governments rushed to form shell SOEs that would allow them to borrow. Over the next six years, China's nominal GDP roughly doubled, ballooning from around $4.5 trillion in 2008 to just over $9 trillion in 2014.


China recovered from the 2008 financial crisis faster than any of its peers, and it drove unprecedented growth in the process, expanding its economy at rates its competitors had failed to match even before the financial crisis. The story was positive enough that some economists called on Western governments to adopt a similar approach, advocating increases in government spending and regulation. Yet China's speedy response would have been impossible to replicate without the power and reach of its central government. The government owns, either directly or indirectly, almost all of China's land and roughly two-thirds of its productive assets, enabling it to quickly allocate resources on an enormous scale.


This advantage carries a significant cost, however, and one that has already begun to surface. According to a recent report from the management consulting firm McKinsey & Company, China's total debt in 2007, counting that of private households, independent firms, and government institutions, equaled 158 percent of the country's GDP. In 2014, it reached 282 percent of GDP--among the world's highest levels for a major economy. In the past, China has been able to rely on a mix of bailouts and local dealmaking to keep toxic loans from poisoning the economy. But now that growth is slowing--a trend party leaders have euphemistically dubbed the "new normal"--many more borrowers are struggling to pay. If China doesn't get on top of its debt problem, the road ahead will be far bumpier than it was in 2008 and could even lead to a prolonged and painful crash.


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