2/16 This debate is important because it will determine how long China's excessively high GDP growth targets can be maintained. If Chinese economic activity is to "grow" by more than the underlying economy can productively sustain, the way to so is by forcing those parts of...

3/16 the economy that don't operate under hard budget constraints (local governments, SOEs, business sectors with preferred access to credit) to boost investment, whether or not that investment is economically justified (and by now it mostly isn't). https://carnegieendowment.org/...

4/16 The result is a surge in the country's debt burden. Normally, in an economy like China's, in which nearly all credit is directed towards investment, rising debt should be more than matched by rising GDP, as was the case before 2006-08. The fact that, since then, credit...

5/16 growth has accelerated while GDP growth decelerated, even as credit continues mainly to fund investment, suggests that China has been misallocating investment for decades, leading to what has been perhaps the fastest growth in history in a country's debt-to-GDP ratio.

6/16 At first this claim, that China was misallocating investment on a large scale, was controversial. But over the past several years it has become much less so, and the very fact of the current debate suggests that by now most economists implicitly accept agree.

7/16 That's because if Chinese debt were rising to fund productive investment, you could argue about the structure of the debt, but you would never worry about whether or not the increase in debt were macro-economically sustainable. It clearly would be.

8/16 The article cites Dalio as saying: "Over the long run, debts can’t rise faster than the incomes that are needed to service the debts, and interest rates can’t be too high for borrower-debtors or too low for lender-creditors for very long."

9/16 He's right, not because the debt can't be sustained or serviced. MMTers are right when they say that countries can service debt in their own currencies, and this is especially true in China, where Beijing controls the banks, sets all interest rates, and can restructure

10/16 But they are wrong in claiming that because it can be serviced, a rise in the sovereign debt burden doesn't matter. It does, because if debt rises faster than the value of goods and services produced, the only way the government can service it is through hidden transfers.

11/16 For example, lowering interest rates doesn't reduce debt-serving costs so much as force part of the costs onto net savers (mainly households). Likewise inflating the debt away transfers part of the costs onto those with fixed incomes or monetary assets.

12/16 There are many other ways these excessive debt-servicing costs can be transferred onto other sectors. Governments have done so by raising direct and hidden taxes on businesses and households, by expropriating assets and income, by manipulating prices, and on and on.

13/16 But because businesses and households are intelligent, they change their behavior in ways designed to protect themselves from bearing more of these costs, often cutting spending on investment and consumption. This "financial distress" behavior always leads to slower growth.

14/16 The important point here is that when an economy invests $100 of resources in a project that creates more than $100 in economic value, it becomes richer. If the project creates less than $100 in economic value, it becomes poorer.

15/16 The locus of the borrowing and the structure of the debt don't change the overall value of the investment. They mainly affect the distribution of costs or benefits. That's why debate in China should not be about the risk of a rise in government debt leading to a crisis.

16/16 Given government control over the banking system and over the structure of liabilities, a debt crisis is extremely unlikely. The debate should really be about the extent to which rising debt is funding wealth destruction rather than wealth creation.

@michaelxpettis Have to agree with a lot of what Xu says - economies are not fixed (input-output) machines. Especially in an economy where people can't leave China can print currency forever. And anyway I thought net debt in China is very low? Ray might be right for W nation w free capital?

@michaelxpettis Dalio’s right; Xi Gao gets brownie points as the ship settles and slowly parts under the waves.

@michaelxpettis Very insightful as always. Thanks for sharing.

@michaelxpettis It should be "Xu Gao", in case anyone mistakes this as "Xi & Gao".