Review: Dinny McMahon's Great Wall of Debt, an economic survey of China

China has a long and inglorious history of economists predicting its imminent collapse. In 2001, Gordon Chang published the stridently named The Coming Collapse of China. A decade later, Jim Chanos, the hedge-fund manager who predicted the end of Enron, said China's economy was on a "treadmill to hell".  And In 2014, George Soros told his followers that the Chinese growth model had "run out of steam" and problems would come to "a head in the next few years".

Dinny McMahon, whose book The Great Wall of Debt seems set to be this year's China blockbuster, points out that "no crisis has been prophesied as repeatedly and for so long as the one that has so far failed to materialise in China."

So how does McMahon, a long-time Wall Street Journal correspondent to China, fluent Mandarin speaker and fellow at MacroPolo an influential think tank seeking to decode China's economy, end up at the same conclusion, that China could go bust? The message of his book is that the Chinese economy has foundations of clay and the foundations are mired in debt, huge debts.  At some point, though McMahon isn't explicit when, Beijing will no longer be able to control and contain it.

His analysis has generated attention and mostly positive commentary.

McMahon, who gave a fascinating interview to Radio New Zealand's Nine to Noon recently, sees the Chinese economy as moving further and further from Beijing's control.

Beijing has had its pedal to the floor in a desperate effort to grow China, to lift people out of poverty and to break out of the "middle income trap" in which fast developing countries get stuck at a middle level (like Thailand) rather driving on to being developed (like South Korea). The World Bank estimates only 13 of 101 middle income economies in 1960 made the leap to high income by 2008.

Beijing has economic levers to pull that Western economies can only dream of - State-owned Enterprises, central control -  but, McMahon argues, the more the state has pushed the economy, the more it has lost control locally.

"The mountains are high, and the emperor is far away" ( Shan gao, huangdi yuan) the traditional Chinese saying goes to explain away subverting the state's wishes. Or as local politicians say shang you zhengce, xia you duice, "above there is policy, but below we have ways of implementing policy".

The result is an explosion of local uncontrolled development, speculation credit binges and debt.

McMahon visits zombie cities far from Beijing, filled with empty apartment buildings, dysfunctional factories, skyscrapers built on speculation and hope, manufacturers making more money by speculating in real estate than creating goods and out of control lending.

China's debt-to-GDP ratio - about 280 percent - is now bigger than the US, Japan and other countries and much of it gained since the Global Financial Crisis of 2008.

"The real problem is not the overall size of the debt, it is the pace at which it has been accumulated.

"Other economies that have experienced a comparable aggressive increase in debt in a comparably short period of time have invariably experienced financial crises."

McMahon wisely tells the story of this economy in full stimulus mode from the bottom up, where the waste is most visible, and well away from the places tourist visit.

He meets the mayors of lower-tier cities desperate to maintain growth who have borrowed for infrastructure to keep people in jobs. The result is subways, motorways and new suburbs but also half-empty business parks, suburbs with few residents - and local debt. Mayors who keep their area growing are promoted - away from their debt. The next mayor must keep growth going. The result, more debt, more bloat.

Then there is the housing boom. Construction accounts from around 30 percent of China's gross domestic product and the long construction boom has seen huge fortunes made from land speculation. China has managed one of the largest shifts in population from country to cities, but it is slowing. Apartment blocks built to house rural workers presumed to be coming,  lie empty. Other blocks are built purely to make a profit from the rising value of units. The pace of price rises means there is no point in renting them out; the profit lies in selling them in a few years.

Tourists to China often see the extraordinary scale and success of developments like Pudong in Shanghai, once farmland with some warehouses, now a centre of massive skyscrapers. But there are few Pudongs and many ghost towns, says McMahon. "To call them towns doesn't do justice to their scale. A city of villas and apartment buildings that were built to one day accommodate a million people rises from the Inner Mongolian steppe but it remains largely empty years after a local financial crisis ended the construction boom. A city of a few dozen office towers that bills itself as China's Manhattan sits pretty much empty on the outskirts of Tianjin."

Recently the Wall Street Journal called them "Potemkin villages" (fake portable villages built by the lover of a Russian Empress to impress her during a tour of the Crimea).  At night only a few lights go on in these tower blocks, often in the middle of nowhere. McMahon describes standing outside to see how many rooms are occupied, compared to the rhetoric. China's Google, Baidu, tried to monitor searches by tower block to estimate users, in the absence of any official figures.

McMahon does an excellent job of explaining macro-problems through micro-pictures. Here are peasants losing their productive land for tower blocks. Mayor "Bulldozer" Ji pushing through huge speculative land deals (only to be arrested in President Xi's anti-corruption drive). The workers of the state-owned "Second Heavy Machinery Group" building bigger and bigger forges for less and less work. Or Liu Jianfeng who speculated on over-priced auctions of Moutai, China's best brand of rocket-fuel baijiu liquor, only to have the market collapse when no-one wanted to be seen to be buying bottles at tens of thousands of dollars during one of Xi's corruption campaigns.

It makes The Great Wall of Debt an entertaining read but it is also smart investigative journalism. The workings of Beijing are opaque and hard to fathom. Visitors are seduced by the explosive growth of the great cities. Plus official statistics are sometimes hard to believe. (Premier LI Keqiang is famously said to have told a US diplomat that he was doubtful of provincial stats, according to a Wikileaks document). So McMahon bypasses these to focus on ordinary people on the outskirts of town and the visible workings of the economy.

But if there is a "Great Wall of Debt", where did all the money come from? In one chapter entitled The Great Ball of Money, McMahon sets out how credit has exploded. A shadow banking system has grown up to feed the demand for loans and money, effectively bypassing bank control. He is especially strong in explaining how China's WMPs (or wealth management products which people can invest in) look safe but are troubling. "China's financial system is increasingly looking like that of the United States prior to the Lehman Brothers bankruptcy."

Perhaps the strongest facet of McMahon's book is its tone. He approaches each strand of the economy with a journalist's fascination but also with sympathy. He takes no delight in what could happen to ordinary Chinese if he is right, even while relishing his hunt for economic truths. McMahon learned Chinese as a young boy when his father managed the Pilbara mine in West Australia for first Japanese clients and then Chinese. He seems to want China to succeed, but fears it may not.

The question that McMahon grapples with it at the end is what this could mean for countries like New Zealand or the world in general if China stumbles. It may not be a banking crisis, he predicts.

"Beijing has deliberately and quite successfully insulated China's financial system from the rest of the world, such that problems in China are unlikely to result in international financial contagion. Rather, the effects will be felt as economic demand begins to  slow."

Fewer tourists and students may come to New Zealand. Exports to China of primary products could slow down. That could be a problem for countries like New Zealand dependent on sales of dairy products and wood, as well as Australia with its mining. New Zealand has seen its two way trade with China grow quickly since the signing of the Free Trade Agreement a decade ago, to become our number one trading partner.

What comes through in McMahon's account is palpable desperation; an urgent need to keep growth going, an economy locked in continuous stimulus, an urge to alleviate poverty, for China to gain developed status, attain a commanding position in the world, even if it means presiding over ballooning debt and housing bubbles.

McMahon is strong on detail, has an eye for telling facts and tells captivating stories of ordinary people. There have been a number of books recently trying to explain the contradictions of China's growth - one of the most talked about last year was the China Conundrum: Why Conventional Economic Wisdom is Wrong by Yukon Huang, the former China director for the World Bank. McMahon's book is as good. It is a good starter on China's economy beyond the bright lights and hype, as well as a persuasive argument.

So is a reckoning imminent? McMahon makes no predictions. He says that Beijing still has great power to avoid an economic collapse. In 2015 when the Chinese stock markets tanked, Beijing stepped in, ordered fund managers to buy not sell, directed news agencies to write optimistic reports and forced a journalist who broke bad news to apologise on state television. But, equally, it is getting harder and harder to reform the Chinese economy, he believes. Kicking the debt can further down the road just won't cut it soon. There are few magic bullets left for President Xi and his government. " As yet, Xi Jinping doesn't have much of a track record as an economic reformer," McMahon says. No-one in China under 40 has experienced anything other than growth, often spectacular, but there is always a reckoning. At some point, debts have to be paid.

"China looks poised to suffer a painful and uncertain end to its economic miracle."

Sometime.