China's Potemkin economy

Over-investment and a failure to write off bad debts will create progressively less economic activity.

Two views prevail when it comes to China’s debt crisis pessimists are concerned about a catastrophic crash, while optimists predict a soft landing as gradual reforms correct the systemic issues.

The crash scenario is predicated on continuing increases in debt levels and over-investment, as policy adjustments are fatally delayed and authorities are ultimately forced to tighten credit aggressively, triggering failures in the financial system and a sharp slowdown in growth.

Weaknesses in financial structures exacerbate the money-market tightening, causing liquidity-driven problems for both vulnerable smaller banks and the shadow banking entities. The rapid decline in credit availability results in problems for leveraged borrowers, such as those in...

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