Commentary on Political Economy

Wednesday 23 August 2023



China’s Slowdown Isn’t Xi’s Biggest Problem

The Chinese leader could soon find himself staving off two different economic crises. One threatens his hold on power. 

Xi sees a sea of red.

Photographer: Michele Spatari/Bloomberg

The Chinese proverb, “disasters come in pairs,” aptly describes the dilemma facing President Xi Jinping. China’s real economy is stuck in neutral. Growth slumped to a paltry 0.8% in the second quarter. Youth unemployment is so high the government has stopped releasing the embarrassing figures. Analysts are warning that the country’s four-decade growth miracle has ended and China may never surpass the US to become the world’s leading economy.

As concerning as the slowdown may be, however, its political repercussions should be manageable. The real threat to Xi’s hold on power is the other potential disaster looming in front of him and China: a financial meltdown.

It is too early to tell whether China is facing such a “Lehman Moment.” But the odds of a full-blown banking crisis have grown significantly because of the implosion of the real-estate sector and the mounting financial distress of local governments. The recent liquidity crisis suffered by Zhongzhi Enterprise Group Co. Ltd., a giant financial conglomerate with roughly $137 billion in assets, has raised fears of wider problems in China’s $3 trillion shadow banking sector.

Slowing economic growth will inevitably lead to higher unemployment, greater austerity and a stagnant standard of living — quite unlike the ever-rising fortunes the Communist Party has implicitly promised Chinese citizens. That would undermine Xi’s image as a capable leader at home and limit his global ambitions.

Elites would be less affected, though, and even for others, the pain would likely be felt only gradually.

By contrast, the consequences of a financial collapse would be more dire, immediate, and unpredictable. Financial contagion usually spreads at lightning speed. Credit flows grinds to a halt and panic precipitates runs on otherwise healthy institutions. The real economy feels the devastation instantly, resulting in mass unemployment.

No corner of the country would be spared. Victims would number in the hundreds of millions. Savers who lose money, homeowners who have prepaid for apartments that will not be built by bankrupt developers, unemployed workers, and newly laid-off local government employees could all become sources of social unrest.

Unlike with unemployment figures or other data that can be massaged or obfuscated, the government would have little hope of concealing a financial disaster of such magnitude. Worried depositors would line up outside financial institutions clamoring to get their life savings out, as we have already witnessed in the Zhongzhi case.

If millions laid siege to banks and trust companies across the country, China might not have enough police to disperse them. At the very least, the public spectacle of riot police brutalizing citizens whose sole demand is to get back their life savings would be hugely embarrassing for the party.

Finally, Xi would have a hard time blaming others for the catastrophe. Were the economy to enter into a long period of stagnation, he could always portray China as a victim of US economic warfare.

On the other hand, most Chinese would attribute any financial crisis to the sustained debt buildup during Xi’s decade in power: Total debt in the non-financial sector grew from $17.6 trillion to $52.1 trillion from 2013 to 2022, according to the Bank of International Settlements. They would remember the incalculable economic losses inflicted by Xi’s Covid-zero policy.

Acutely aware of the dangers, Xi and his lieutenants appear to be moving more aggressively to address potential financial contagion than to stimulate the economy. At the last Politburo meeting on July 24, they decided to roll out a “package of solutions” to address the risks posed by local government debt and highly vulnerable small- and medium-sized financial institutions.


Although the government has not disclosed any details, its past record suggests that the rescue package will likely include a bit of everything. The central government may take over a small portion of the debt borrowed by local governments. It will count on financial engineering, such as restructuring the terms of outstanding loans, to do most of the heavy lifting. Some debt will be monetized through the printing of more paper money even though this will put more downward pressure on the Chinese currency.

Nobody knows whether another band-aid approach can stave off a systemic financial crisis. Given the political stakes involved, though, Xi would be well-advised to do “whatever it takes” to prevent one.

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