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China's 'Bad Debt' Problem: Why It's Not Learning From Japan

China is awash in "bad debt," but can it learn from Japan's experience overcoming the collapse of the 1980s bubble? Here's what China would need to succeed.

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Chinese 100 yuan banknotes are seen in a counting machine while a clerk counts them at a branch of a commercial bank in Beijing, China, March 30, 2016. (REUTERS/Kim Kyung-Hoon)

The final collapse of Chinese real estate giant, Evergrande, is the latest evidence – as if any was needed – that the People's Republic of China (PRC) is awash in "bad debt." 

There has always been bad debt in the PRC. But now it's mammoth. Like Texas, in China, everything is bigger – even if not better.

The men in Zhongnanhai are rightly worried.

First a Tutorial

"Bad debt" – someone borrows money and provides collateral to the lender. If repayment isn't made according to loan terms the loan is declared in default. Then the collateral is seized to compensate the lender for the money they lent. 

The debts often involve borrowing to purchase real estate but can be on other assets too. 

Enough loan defaults lead to ripple effects and loss of confidence throughout the entire economy. 

This in turn leads to more bad debt.

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Banks themselves get in trouble. They may have collateral – but nobody will buy it as they don't have money or don't know what it is worth. 

A government needs to clean things up and dispose of the debts or else it gums up the entire economy. Think recession or even depression. 

A recent article in the Financial Times was filed by Gillian Tett, who ably reported from Japan in the 1990s. She suggests China could learn from Japan's experience cleaning up its own massive bad loan problem in the 1990s and well into the 2000s – following a real estate lending mania during the 1980s "bubble" economy when the entire nation seemed to go insane.

Learning from Japan?

I had a front-row seat to the cleanup effort. There are lessons, but I doubt Xi Jinping is interested.

The first lesson the Chinese Communist Party (CCP) might learn from Japan is the need for an honest, impartial legal system that's free of official influence.

Then there's the simple ability to enforce a contract.

 Next, you need guaranteed property rights.

And all of these flow from a system of consensual government.

Japan had all of these. The People's Republic of China does not – and appears intent on keeping things that way. Otherwise, Party control is threatened.

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There is only one hand guiding the Chinese economy and it is the hand of the CCP.

Our bank did well from Japanese bad loans. The approach was based on using legal process. And you could do that in Japan. Court rulings are obeyed. If organized crime (the yakuza) who were often (but not always) involved in the bad loans – wanted to take on the judiciary and interfere with court orders…they were free to do so. They didn't – at least when it came to foreign firms.

We also refused to pay off the yakuza or enlist their help as some other financial outfits reportedly did.

In the 2000s, one foreign bank tried to replicate its success in China. It failed. It couldn't enforce its rights, even when it had also enlisted someone with "connections."

Invariably, the debtor would find somebody with better connections who would obstruct the resolution process.

The People's Bank of China in Beijing (©Kyodo)

Two Very Different Systems and Societies

Another major difference that made things easier in Japan was the basic confidence the average citizen had in the government and its competence – despite no shortage of scandals over the years.

Japan also has elections – fair ones too. The citizenry could vote politicians out of office, and even an entire party. And the Japanese press – parts of it at least – did its job well enough exposing official wrongdoing.

This tended to serve as a pressure release valve of sorts that could absorb even a disaster like the "bubble" collapse.

One gauge of this confidence in their system is that Japanese people have never rushed to move their wealth out of the country. This is unlike in China, where the move is ideally along with a relative with a residence permit – to the US or some other free nation. 

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Different People

One fairly notes another huge advantage for Japan in cleaning up the bad debt.

It's the Japanese expression shoganai. It means it can't be helped, or "that's life."  As a result, the Japanese put up with all sorts of things that no other people on earth would.  

The bubble era hangover – and the official and financial class malfeasance that caused it – was just one of those things. Nobody liked it, but "shoganai."

The Bank of Japan headquarters in Chuo Ward, Tokyo. (© Sankei)

Letting Foreigners Help – And Profit

Another advantage for Japan was that they bit the bullet and allowed foreign financial firms to play a major role in the debt workout process.

This got a lot of bad press. The foreign firms were referred to as "vulture funds." Then, too, there was plenty of official resentment of outsiders taking advantage of Japan's misfortune. But they were allowed to operate – and supported.

One can't imagine Xi Jinping allowing foreign financial companies to "do the necessary" and subject the CCP-ruled People's Republic of China to another few years of "humiliation" at the hands of foreigners. 

He might offer up a small project to tempt in a few Western firms. They would be used to show the CCP is serious and applying "high quality" approaches. Beyond that, it's hard to imagine.

Arguably, without the foreigners, Japan would have had a much harder time. Besides distracting attention from who caused the bubble era excesses, there was the small problem of the Japanese underworld. They'd made their position clear early on. Japanese banks collecting on bad debts in which the yakuza stood to lose was an unhealthy proposition for those bankers.

Harming foreigners was a different matter. And the authorities would have had to crack down on the yakuza, thus harming the groups' broader moneymaking interests.

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What was the Yakuza Involvement in Japan's Bad Debt?

It's debatable, but from my perch, I'd estimate that a huge percentage (90% if I had to give a figure) of the first $200-300 billion USD in loans that went bust had a serious yakuza taint. The Japanese government held back. Beyond fear of bankers getting hurt, the deep involvement of politicians, bankers, and officials would have been exposed.

This seized up the financial system and the economy. The ripple effect caused a lot of other bad debt – much of it without yakuza connections. But the damage was done.

Chinese Vice Premier He Lifeng, right gestures to US Treasury Secretary Janet Yellen during a meeting at the Diaoyutai State Guesthouse in Beijing, China, Saturday, July 8, 2023. (©Mark Schiefelbein/Pool via REUTERS)

Help From Where?

Japan also benefitted from having actual and potential support from the United States and other Western nations that saw Tokyo as an integral part of the free-world system.

Exactly who will help China? Russia? Cuba? Iran? 

As crazy as it sounds, the Biden administration might step in to prop up the country that refers to America as "the main enemy." It's the same country that is building up a military to kill Americans. 

One is properly skeptical of what's going on at the recent meetings between US and PRC financial officials. 

Resolving China's huge bad loan problem just might be beyond the CCP and its officials. After all, they have no special expertise beyond anyone else on earth when it comes to running an economy.

But if the US government, Wall Street, and the "two-standing ovations for Xi Jinping business class" keep pouring money and technology into China, that just might keep Xi Jinping afloat for a good long while – bad debt or no bad debt.

But if Washington steps back and says, "We love you, but it's your problem," the entire CCP Ponzi scheme will be in all sorts of trouble.

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And that would be a win-win.

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Author: Grant Newsham
Grant Newsham is a retired US Marine officer and former US diplomat. He is the author of the book When China Attacks: A Warning To America. Find his articles on JAPAN Forward.

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