China's Bear Stearns Moment Is More Likely a Slow Burn

Listening to the short sellers, one could be forgiven for expecting the imminent toppling of China’s once-envied economy.

Stock traders have doubled bearish bets against some of China’s biggest property developers, while a smaller one, Zhejiang Xingrun Real Estate, was unable to pay creditors that included more than 15 banks and collapsed just days ago. That came less than two weeks after Shanghai Chaori Solar became the country’s first company ever to default on an onshore bond—an episode dubbed China’s “Bear Stearns Moment.”

Despite signs of impending doom, expect a slow burn, rather than sudden meltdown. Yes, China’s economy has become way too leveraged, with non-financial corporate debt amounting to $12 trillion, or 120 percent of gross domestic product, as of the end of last year, according to Standard & Poor’s. Still, Beijing has the financial muscle to stop any big defaults by the companies it cares about, and it will make sure that those chosen ones—usually state-owned enterprises—survive to see many further days.

It’s hardly as if defaults were unexpected; people predicted them for a while. Many—including some members of the Chinese government—have been calling defaults necessary to start solving the moral hazard problem that plagues China’s economy. So yes, there will be more defaults, particularly by companies in sectors facing overcapacity such as Chaori Solar. Real estate companies in China’s lower-tier cities, many of which are dangerously overbuilt, may be allowed to go bust, too.

Still, a countrywide property bust—what many have been calling the likely trigger for economic doomsday—is unlikely to impend. If anything, the new leadership has proven more cautious than its predecessors when it comes to placing serious curbs on the real estate market. (It hasn’t figured out how to support China’s local governments if towns and villages are prevented from relying on land sales to developers to raise funds.) Moreover, China has multiple real estate markets, and some are doing pretty well.

The bigger problem is that the government won’t let more defaults happen—and sooner—and won’t start the serious deleveraging process that the economy needs. Far more likely, regulators will let selected smaller companies go bust while ensuring that property prices stay higher than they should be, all the while continuing to run the economy on the fumes of ever-higher debt.

This means we all will have to wait much longer for the Chinese economic rebalancing everyone knows is needed. It also probably means a much slower pace of reform than many have been hoping for. The current policy merely delays the eventual day of reckoning: when China’s economy must break what could by then be a much more dangerous addiction to debt-driven growth.

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