“Decay is an easier political choice for China's leaders, accepting the slowdown in growth and the inefficiency of policy tools rather than risk crisis. Because the path to crisis is not an external shock in China, where everyone assumes the government is going to provide support. The path to crisis is reform.”
ChinaTalk · Geopolitics & World Affairs · September 2026
Brad Setser had asked why China's enormous post-2008 credit expansion never ended in a catharsis like 2008 in the US or Spain's banking collapse. Wright's answer, and the thesis of his book Broken China, is that there was no single crisis moment because Beijing keeps choosing slow decay instead, and that the reforms outside observers keep calling for are precisely what would trigger the reckoning. He dates China's nearest equivalent to the Evergrande protests of September 2021.
Transcript
Sure. And so the book tells this story about first, this is a story of contingent futures and outcomes. It is not this was inevitably going to go down this path. This is the result of distinct policy choices along the way in terms of how the financial system operated. And so after the global financial crisis, China saw the largest single country credit expansion that the world has seen in at least the last century, possibly many centuries. China added a third of global GDP to its bank assets in just eight years. And we've never seen anything remotely like this. There's a few aspects of that. First, there was a deliberate attempt to provide this sort of credit expansion to provide countercyclical policy support during the global in the response to the global financial crisis. But the extension of it after that was essentially a form of path dependence. Growth was strong. It was dependent upon investment. And then it became too difficult for authorities to shut down without imperiling the overall economy. And so as a result, you had a variety of different developments that took place that facilitated the growth of the shadow banking system. And growth was in credit was increasingly disconnected from the real economy itself. And fundamentally, a lot of credit went into the property sector and into local government infrastructure investment. After the deleveraging campaign started in 2016 and really intensified by 2018, you had a sharp decline in overall credit growth. And as you had that sharp decline in credit growth, and this coincides, and there's a lot of discussion in the book with Xi Jinping's rise to power and how that changes financial risk. And we should talk about that distinctly. But you now have credit that cannot expand at the same rates because you already had a financial system that's overextended. And rather than write down the malinvestment from previous years and the loans that had been extended in previous years and the losses from the shadow banking system, what you have instead is a financial system that basically provides everlasting life to state-owned producers and local government financing vehicles, but cannot maintain the same pace of credit growth. So credit becomes less and less efficient. It generates less growth at a lower quantum of credit growth overall. And as a result, you have the decline in overall investment. The number one cause of the rapid decline, though, since 2021 was the collapse of the property sector. And it's critical to understand the collapse of the property sector as a proximate cause, but not the ultimate cause of China's slowdown. The property sector was basically reinflated after the deleveraging campaign by borrowing from households in the form of pre-construction sales. So deleveraging basically impacted developers' shadow financing channels. And then they replaced that by putting up showrooms, borrowing essentially from and selling properties in advance for which homebuyers borrowed. And so when the defaults happened, they happened largely against homebuyers themselves who were just waiting for their apartments to be delivered. And that collapse in confidence started weakening construction activity across the economy. So property was 20, 25% of China's GDP at its peak. You know, there's various measures of that. Construction has fallen almost 80%. Sales have fallen about 60%. Nothing has really replaced the property sector as a driver of growth. And that is really why the slowdown is taking place. But the other part that's underappreciated still, I think, is how the slowdown in domestic demand and from property construction is directly related to the rise in China's external surplus and supposed competitiveness in external markets. And so it has been a byproduct of falling prices, but also just the continued production across a variety of different industrial sectors that used to be able to find demand in residential buildings in China itself. There was demand for those to be constructed. And now there's not. And so, as a result, they need to find markets abroad. And they're typically cutting prices in order to do so. And this has produced persistent deflationary pressure within the Chinese system, as well as a weakening of the real exchange rate over time. And those phenomena, the slowdown in domestic economy and the rise in the external surplus are very closely linked, but people still treat them as distinct to a greater extent than they argue the economy is K-shaped when in reality, that has been the pattern of development. But these are basically the same phenomena.
Well, Look, one question, I guess, is really two questions. This massive credit expansion could arguably be called unique, not just because it was so big, but because it didn't generate an external deficit, wasn't financed by an inflow of funds from abroad, which is somewhat unusual given its size. It'd be perhaps helpful to discuss why China and why that happened, why such a huge credit expansion, such a heavy investment in the property sector never spilled over into an external deficit. But then there's also an argument that this credit expansion ended without a crisis. Nothing like the U.S. experience in 2008, nothing like Spain experienced with its banking sector. There's never been a moment of catharsis. There's never been a moment when key parts of the financial sector seem to lose access to financing. So it's, I think, interesting also to ask: why was it possible to have such a big crisis, I mean, a big credit expansion without it ending in something that more clearly approximates the kind of financial crisis most countries experience after such a big windy
sure. Let me talk about the crisis moment first. I would argue China had the equivalent, first of all, you know, the crisis is the story I tell in the book is a story of, it is not a story of crisis or collapse, but decay over time of policy tools of an attempt to forestall these immediate crises at the cost of longer-term adjustment. And that's really, I think, one of the themes of the book, that decay is an easier political choice for China's leaders, accepting the slowdown in growth and accepting the inefficiency of policy tools rather than risk crisis, because the path to crisis is not an external shock in China where everyone assumes that the government is going to provide support. The path to crisis is reform. And the other answer that I would have on that front is I would argue China had that cathartic moment. And in fact, that's exactly what the book leads off with, which is the protests in the lobby of Evergrande's headquarters on September 13th, 2021. And what happened there was China's largest firm in its most important industry could no longer meet its obligations to its own employees who were basically lending money to the firm. And so they started protesting, were ultimately not repaid. And when China's largest firm and its most important industry effectively defaults and later defaulted on its external obligations as well, and then later defaulted on homebuyers, it raises a question of what else is going to provide economic growth in the economy. And so if you told me that an economy had a financial crisis at date X and asked me what would be the consequences for the economy at X plus five years, which is where we are right now, and I would date it to that sort of moment, I would argue this is entirely consistent with the aftermath of a financial crisis. We see policy tools that are highly impaired that cannot deliver the same sort of countercyclical policy response. We see persistent deflationary pressure. We see continued pressures for defaults, especially as credit risk has migrated from the periphery to the center of the Chinese economy, from peer-to-peer lending networks in 2018 to small banks in 2019 to trust companies in 2020 to property developers in 2021 to individual mortgage loans in 2022 to local government financing vehicle risks in 2023. So you see that start to intensify and you see much slower growth and reliance upon external markets because of this inability to generate domestic demand. So all of those, the things that you would sort of expect to see and impaired and zombified financial systems as well are essentially taking place. So I would argue the consequences Are kind of the same. China's credit expansion in the post-global financial crisis world was essentially externally financed through the steady inflows of deposits into the banking system from exchange rate intervention and from reserve accumulation until about 2013. And so the change in that pattern in late 2013, 2014 is exactly what forced this increasing reliance upon non-core liabilities and banks to start competing with one another for wealth management products and competing on higher interest rates. So you started seeing these huge maturity mismatches between higher interest rates for short-term financing of this rising pool of assets on the other side because you no longer had this steady growth of deposits into the system. So there was an external financing component, but I take the broader point that this didn't spill over into a, you know, an external deficit at any point.
I just wanted to maybe spotlight some of Logan's pros from the book. For years, long-term trends in China's economy and financial system have appeared unstable. Everyone asks, you know, when's the crisis coming? But the more precise question to ask is how long can these trends continue before China faces the same economic outcomes as a financial crisis? The answers are clearer as these consequences are already apparent in China's economy and the decay of the financial and fiscal systems. China's already seen a sharp slowdown in economic growth led by its vitally important property sector and local government infrastructure. Investment, private sector credit remains weak, similar to the effects of a shock to aggregate demand. The downshift in economic growth is structural in nature, as the economy is unlikely to recover to previous growth rates. So, you know, even though we didn't have something quite as dramatic and sort of nationwide as say a 2008, what you're living with is like some version of this like permanently suppressed growth that, you know, you saw post-Japan, you know, mid-1990s.
Yeah, I mean, I think there's, there's, there's differences with Japan scenario, but Japan's probably the closest analogy in recent history. And I think the difference with Japan is that Japan had zero-bound monetary policy. Therefore, you know, they had to rely upon fiscal stimulus to solve the sort of balance sheet recession problem. I'd argue China probably still has more space with monetary policy to act. The constraint is on the exchange rate and the constraint is on the stability of the financial system rather than getting rates lower. They certainly could get rates lower. It would just introduce different trade-offs. The constraint China faces is fiscal in nature. You're already running a 9.5% of GDP fiscal deficit, about $2 trillion fiscal deficit last year. You can run that deficit to 15, 16% of GDP. You're probably not going to generate that much more economic activity unless you're fixing the underlying system resulting from it. And so I appreciate you reading that. That's exactly sort of where I think we are at this stage. It's not that there are not choices available to offset some of the immediate short-term pressures that China faces. It's that without resolving some of these structural issues, you really shouldn't expect a fundamental improvement in the overall outlook. And, you know, the property crisis was nationwide in China. And it was the, you know, the amplification you had, as I, as I argued in the book, you know, you had a bank run. It just wasn't at a bank. You had property, you had, you know, basically homeowners wanting their money back, quote unquote, in the form of we want our properties built. And developers were unable to actually deliver them because they had borrowed forward essentially in order to continue to buy land and support their own businesses.
All right, Logan, you know, cute Western PhD thinking he's got all the answers. I'm Xi Jinping. I'm here to get to stabilize party rule and to make China a world power. And how am I defining world power? I'm not defining world power by ghost cities and second homes for middle class people and Hebei. I'm defining national power by the ability to build everything that the world needs, get the world dependent on all my manufacturers, capture the heights of the 21st century, of the 21st century technology global economy. And look, if that means, you know, squeezing our consumers so they have slightly worse worse healthcare and services, if that means, you know, stressing folks out so they don't have savings and, you know, they can't. Get a good return on the money they have sitting in a bank? Fine. I was sitting with an economy that was working towards goals that I don't think are in line with national rejuvenation. And now it is. Look at all of the manufacturing powerhouses that have been built by world-leading, technologically vibrant manufacturing powerhouses that have been built over the past 15 years. What's wrong with that?