Readers may know that economist Steve Keen was among the very few that predicted the 2008 crisis. In the video below he briefly recaps his analysis, that it is the level of private debt and not government debt that creates meltdowns. Other analysts such as Richard Vague have come to similar conclusions.
Keen points out that he saw the rise in the private debt to GDP ratio to 170% as a red alert before the 2008 meltdown. I am not sure where he gets his data from, since one chart he displays briefly shows elevated private debt levels to GDP now, but below the 2008 level.
The World Bank shows US private credit, aka debt, to GDP as 198.2% for 2024. That indeed looks seriously bad.
However, Keen mentions only the US and the UK in his talk. The World Bank shows China’s private debt to GDP at end of 2024 as 194.2% The CEIC database depicts China’s level as 199.35% as of end of June 2025 versus 141.25% for the US at the same quarter end. So there seems to be a considerable difference in approaches as to how to run the US numbers, and not so much for China.
In addition, Keen warns, following Minsky and originally Irving Fisher, that debt deflation is what does real damage in recessions and if not arrested, causes depressions. Japan’s now lost three decades is an example of a very attenuated unwind of a massive private debt binge. Japan has been in borderline deflation this entire time.
China is now in deflation. It is also exporting deflation, witness Thailand now experiencing eight months of deflation.
Deflation (falling prices) is not the same as disinflation (a decline in the rate of price increases). Deflation is destructive. The cost of debt rises in real terms in deflation, so bankruptcies and defaults rise. Because wages are sticky, workers are typically fired rather than having lower pay forced on them, which accelerates the economic downdraft. Due to conditions being poor, plus prices being on the decline, consumers tend to hold off on spending, exacerbating the depression.
Recall that in 2008, China played a big role in blunting the severity of the global shock by engaging in massive stimulus. That does not seem like a likely action now.
In case you doubt this grim forecast, that China looks at least as likely to generate a crisis as the US, consider this section of a new post from China Economic Indicator that we also have in Links today:
The CEI’s 2025 Fixed Asset Investment (FAI) Report exposes the fracture. Growth in this critical indicator, accounting for two-fifths of GDP, has decelerated to 3.8%, pulled down by the continuing seizure of its historic engine: real estate, where investment shrank by 2.1%. The state’s counter-cyclical response is visible in a 6.4% surge in infrastructure spending, yet this stimulus is applied with unprecedented caution, hemmed in by a colossal $9 trillion debt overhang in local government financing vehicles (LGFV).
This presents the core dilemma: China’s growth remains irreducibly tied to capital spending, but the traditional channels are either broken, in the case of property, or saturated and debt-laden, as with traditional infrastructure. The intended pivot is toward manufacturing, in particular high-tech and green sectors like EVs, which shows resilience at 5.2% growth. However, this sector still comprises only 28% of total FAI—not enough to counteract the downdraft from real estate’s decline. Every percentage point of FAI growth now represents a struggle between the gravitational pull of a debt-fueled past and an ambitious but perilous climb toward a more sustainable future.
The Human Cost: A Converging Employment Crisis
The faltering investment engine has a direct and devastating human consequence: structural unemployment. The symbiosis that once defined China’s model—where relentless FAI acted as a sponge for millions of migrant workers and graduates—is breaking down. As real estate contracts and infrastructure spending becomes more targeted, its job-creating power diminishes. The manufacturing investment that remains is increasingly automated and high-skilled, failing to absorb those displaced from construction and traditional industries.
The result is a dual-engine failure. Youth unemployment is estimated at over 25%—see CEI’s Unemployment Report 2025—with severe regional disparities hitting the old industrial northeast. This convergence of weak investment and entrenched joblessness fuels a deflationary vortex: overcapacity in traditional industries pushes prices down, while weak employment depreses consumer demand from the other side. While deflation is in China is not the heart attak it is Western economies, where it can lead to capital flight that can devastate entire secors—it does squeeze profit margins which feeds back into investment pressure and makes local governments debt repayments more difficult. It also risks social fracturing, as Tier-3 cities and the northeast become epicenters of both vanishing investment and vanishing jobs.
The Historical Reckoning
This present convergence is the inevitable reckoning of an investment-led model pushed to its limits. The strategy was staggeringly effective, modernizing the nation and lifting hundreds of millions from poverty. Yet, growth based on piling up capital eventually encounters diminishing returns. The debts taken on to fund this building binge—held by local governments, state firms, and households—now poses a significant financial risk. The model has also created profound imbalances, evident in vacant apartments and industrial overcapacity that depresses global prices. Most critically, it has crowded out the household sector, leaving consumer spending anaemic at roughly 38% of GDP, compared to about 70% in the U.S., and making the economy dangerously lopsided.
It’s surprising to see this post omit that China has had to admit that its manufacturing-driven strategy is hitting a wall in two sectors in which China has global leadership: electronic vehicles and solar panels. In both, it has overcapacity to the degree that both are suffering from destructive price competition that national government has launched a program to try to rationalize those sectors. Mind you, the global car industry is also in a crisis of excessive capacity, which makes the challenge for China even worse. From PlutoniumKun in an early December post:
IMO the biggest problem the automotive industry is facing is not Chinese competition in itself, but a consistent build up of debt and overcapacity over the past 3 decades resulting from a belief that market growth worldwide, combined with economies of scale, would allow a small number of big brands to dominate…
This is exacerbated by numerous countries encouraging the process to develop national champions – it’s not just the US, Europe, China, Japan – countries such as Malaysia, Thailand, Brazil, South Africa, Indonesia, etc., all have their car manufacturing ambitions and have invested hugely in trying to compete – although nobody can match the staggering level of overinvestment in China…
But China is in very big trouble over its industry. The overcapacity has to be seen to be believed, and to make it worse, they have hugely overinvested in highly automated plants which give little financial scope to roll back production when needed. Every region and province of China has its own local champion, and will willingly get into unsustainable debt to keep them producing. Something like 40% of Chinese brands are directly owned and financed by local government investment vehicles – in other words, the buck stops with the local tax payer. There will not be a pretty outcome, unless somehow Beijing can come up with another few tens of millions of willing car buyers every year.
As to quality – Chinese cars have struggled with this, despite the comments made above. Their ICE vehicles are still way behind the best worldwide. Even with EV’s, while they can make them cheaper, this is not the same as being able to win market share in foreign markets. European EV buyers want Renault 5’s and Hyundai Insters and Teslas – regular ‘best of’ lists put Chinese brands well down the list. BYD and MG make the most attractive cars for non-Chinese markets, but this is through deep discounting – its unlikely they are making much money. There are many rumours that BYD is in deep trouble. Berkshire Hathaway exited BYD ownership for a reason.
So even though the extremely visible dependence of what passes for growth in the US on AI bubble blowing is an obvious economic/market risk, evidence is accumulating that the many-decades success of China holding off a day of reckoning with its export/investment driven model is hitting its limits. Batten down the hatches.
