A well-functioning trading regime would permit neither the large, persistent trade imbalances that characterize the current global trading system nor the perverse flow of capital from developing economies to advanced economies. Global trade needs new rules that encourage a return to the benefits of free trade and comparative advantage.

If China’s GDP is to continue growing at 4–5 percent for the next decade, either other major economies must be willing to reduce their economies’ investment and manufacturing shares to accommodate China or China must establish policies that cause the locus of growth to shift from investment to domestic consumption. Neither is easy, and the former is very unlikely.

Both Washington and Beijing treat rising debt as a consequence of irresponsible behavior by local institutions. But in China and the United States, rising debt is spurred by policies that have encouraged distortions in the distribution of domestic income. Until these distortions are addressed, both countries must choose between rising debt and rising unemployment.

Beijing’s economic policymakers largely accept that China must rebalance its economy so that growth is driven more by domestic consumption and less by investment. But once China begins to take seriously the need to rebalance its economy, China’s annual GDP growth is unlikely to exceed 2–3 percent for many years, unless there is a substantial increase in the growth rate of consumption.

Policies are not “protectionist” because they violate WTO trade rules. They are protectionist if they distort global trade by generating beggar-thy-neighbor trade surpluses. Because large, persistent trade imbalances would be all but impossible in a well-functioning global trading system, the irony is that U.S. policies to reduce its deficit actually enhance free trade.

China’s large structural trade surpluses are the consequence of internal economic imbalances, which means that any external pressure that results in a contraction of its trade surplus must be accommodated by shifts in these internal imbalances.

In the first half of this two-part blog post, I discussed the problems affecting four rural banks in Henan and the subsequent mortgage boycott in parts of China. In the second half, I argue that these crises need to be seen not as isolated events but rather as signs of systemic problems that reveal a great deal about China’s finances and balance sheet.

The Chinese economy has been wracked by rural bank defaults and boycotts over mortgage payments. In the first half of this two-part blog post, I will explain these events and what they reveal about the health of Chinese markets. In the second part, I will discuss some of the crisis’s systemic implications.

There is increasingly a consensus in Beijing that China’s excessive reliance on surging debt in recent years has made the country’s growth model unsustainable. Aside from the economy’s current path, there are only four other paths China can follow, each with its own requirements and constraints.

Giving up use of the U.S. dollar for global trade and reserve accumulation would be very difficult for U.S. adversaries and would require major economic adjustments, though it would be in the best long-term interests of the United States for the global use of the dollar to be more constrained.