China’s problem is excessive debt in the economy, not a banking system facing insolvency. Beijing’s reform strategy should reduce the debt burden as quickly as possible to minimize the economic costs.
Policies that affect the savings rate of a small country can have more-or-less predictable domestic impacts because the global economy is so large that domestic policies are not affected by external constraints. But with a large economy, the analysis changes.
Instead of a hard landing or a soft landing, the Chinese economy faces two very different options, and these will be largely determined by the policies Beijing chooses over the next two years.
While debt plays a key role in understanding the recent evolution of the Chinese economy and the timing and process of any further adjustment, there seems to be a remarkable amount of confusion as to why debt matters.
The plummeting valuation of China’s banks suggests that investors are losing confidence in China’s growth prospects.