China has a bigger problem than the trade war — a 'mountain of debt'
It's been a few weeks since Donald Trump fired the opening salvo in a trade war with China, slapping tariffs on a range of Chinese-made goods.
Beijing retaliated with tariffs of its own — and since then, the rhetoric on both sides has been unrepentant.
Much of the focus has been on nervous financial markets, and how the war could affect the fortunes of US farmers and manufacturers — but how do things look from China's side?
Is the trade war the biggest threat to China's economy, or does the country have more pressing problems — like its massive debt?
Dinny McMahon, who spent a decade covering China for the Wall Street Journal, says while Beijing obviously isn't welcoming the trade war, it's also unlikely to be crippled by it.
That's because China's economy is no longer driven by exports.
"In 2007, net exports contributed about 9 per cent to China's GDP. Last year we were down to 2 per cent," McMahon says.
"Exports aren't the be all and end all for the Chinese economy, as they once were."
On top of that, he says, the US only accounted for about 19 per cent of China's exports last year.
"So the ... trade conflict with China isn't perhaps the bludgeon that Donald Trump believes that it is, and certainly once would have been," McMahon says.
The big problem for China, he says, is that the trade war isn't happening in isolation.
Massive debt and ghost cities
China is also dealing with a "mountain of debt" racked up at a massive pace over the past decade, as it raced to catch up with the "rich world".
"It has been fuelled by debt at every step of the way, to a point where now Chinese debt levels are in excess of those in the United States."
The biggest problem isn't the overall levels of debt, McMahon says, but the pace at which it's been accumulated.
He says that around a decade ago, China's debt levels were about 160 per cent of the size of its GDP.
"Now it's somewhere between 280 and 300 per cent," he says.
When other countries have accumulated debt that quickly, they have "almost invariably experienced a financial crisis", McMahon says.
"That's like the United States before the sub-prime crisis, or Thailand before the Asian financial crisis," he says.
A lot of the money China borrowed from state banks was invested in infrastructure. Some of the construction was useful, but the non-stop building boom also created 'ghost cities'.
They were essentially built from scratch to accommodate people moving from the countryside into the cities in the future — but that was "nothing more than a fig leaf at the end of the day".
Hardly anyone actually turned up to live in them.
"They do have people living in them but it's almost a skeleton population relative to what they were built for," McMahon says.
He says local government officials were driving the construction boom.
"Their success and their ability to get promoted onwards and upwards is primarily based on their ability to generate economic growth," he says.
"They are invariably in these positions for very short periods of time.
"If you only have three years to prove your ability as a proven economic manager, somebody who can deliver growth, then the easiest way to do that is to borrow a whole lot of money and build something big very, very quickly.
"After three years you'll have the city, or you'll at least have a city in progress, to show everything you've managed to generate.
"But when the debt comes to you, you will be somewhere else, and it will be your successor that has to deal with the fallout."
McMahon, who has recently released a book titled China's Great Wall of Debt, says Beijing is now trying to unwind its debt problem.
But that's making its economy "a lot more fragile that it has been in a very long time".
"It has all these variables which it's trying to manage at the same time, and certainly the trade war is not making things any easier for them," he says.
What could come next in the trade war?
So what could China's next move in the trade war be?
Ratcheting up its own tariffs could be one option.
"But the big problem here is that China exports to the United States far more than the United States exports to China," McMahon says.
"So Donald Trump can keep saying we are going to impose more and more tariffs, and China will hit its limits of what it can impose tariffs on before the US gets to its upper limit."
These limits already appear evident: the latest tit-for-tat manoeuvring saw the US impose tariffs on $US200 billion of Chinese exports, and China respond with tariffs on $US60 billion of US exports.
Another approach China could take involves making it more difficult for US companies to operate in the country.
McMahon uses the example of a company like Starbucks, which doesn't really contribute to trade flows between the US and China, but operates thousands of cafes there.
"It's a great source of revenue for an American company. You could have a situation where China then starts to make life economically difficult for these sorts of companies," he says.
That could involve "the imposition of bureaucratic rules", or alternatively "the courts might make life more difficult for them".
And what about the US?
McMahon says Mr Trump's tariffs would hit harder if he teamed up with other countries and regions, such as the European Union and Japan.
"The combined trade clout that those regions have with China could have a really meaningful impact on China's exports," he says.
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