Over the last few years, the idea that China is destined to pass the U.S. in economic size has begun to be revised. Inherent weaknesses in the Chinese economy from the demography crisis to a banking system that has a significant fraction of bad loans to an overheated property market—things that were only hinted at years ago—have become more visible. The idea that official Chinese economic numbers are unreliable has not only become accepted but may now constitute conventional wisdom. China’s overall reputation took a massive hit during the COVID pandemic, and current discourse is beginning to suggest that India, rather than China, may be the economy of the future over the next 30-40 years.
That being said, China is not going anywhere, and whatever happens in China will be globally relevant. On some measures, China appears strong. It is building out its military, and there is talk of it planning to invade Taiwan, an act that would be unbelievably globally destabilizing as Taiwan Semiconductor, one of the world’s leading producers of artificial intelligence (AI) chips, is headquartered there.
However, there are serious questions as to whether China is destabilizing due in part to some serious weaknesses that have become more pronounced over the last few years.
Overstated Economic Numbers
Over the last few decades, there has been pressure at the local level in China to meet performance expectations, which over time often leads to inflated numbers on the positive side. In the last 15 years, there has been recognition in the West that the economic growth numbers coming out of China are overstated. Some analysts have looked at alternative measures such as value-added tax (VAT) receipts or electricity consumption to enhance accuracy, but figuring out China’s gross domestic product (GDP) growth remains a game of educated guesswork rather than simply using the numbers provided by China. Despite the wider recognition of this, it does not appear that China has taken meaningful steps to clean up its numbers, meaning the actual economic situation in China is not as rosy as the numbers would indicate.
Bad Debt
Perhaps one of the most acute dangers facing China currently is the issue of bad debt in the banking system. It has long been known that China’s banking system has a substantial fraction of its lending directed to state-owned enterprises (SOEs). These firms are politically connected, indicating that some fraction of lending is directed based on political considerations rather than economic ones. Chinese banks appear to be rolling over bad loans to insolvent SOEs to avoid recognizing these losses on their books. According to the Dallas Federal Reserve, which labels these insolvent companies as “zombies,” zombie nonfinancial firms are estimated to hold 16% of all assets in China (with 40% of assets in the real estate sector held by zombie firms). China is now in its fifth year of real estate decline. Trouble in the Chinese real estate market first came to international attention in 2021 when the Evergrande Group (one of the large Chinese developers) defaulted (source: Wikipedia).
Since then, the property bubble has been deflating, which is negatively impacting many Chinese citizens’ perceptions of their own wealth. It also means that many loans held in Chinese banks are undercollateralized (i.e., unrecognized losses). There are indications that things may be reaching a breaking point. In the last year, the price of silver has risen from around $30/ounce (oz) to around $80/oz as of this writing. In January, the price even spiked up near $120/oz in part due to panicked buying by Chinese worried about insolvent banks and feeling that physical assets such as silver were a safer store of wealth (source: Yahoo Finance). While China could weather this crisis as it has others, and the reduction of the price of silver from its high could indicate the panic has subsided for now, the underlying factor that caused it is still there. A national bank run would likely change everything we know about China, as well as who is governing it.
Demographic Decline
Demographers for years have been pointing out that China’s one-child policy (implemented from 1978 to 2015, when it changed to a 2-child policy and now a 3-child policy) would eventually lead to an aging and declining population. Those predictions are now coming true, with China’s population declining for the fourth straight year (source: Asia Times). In fact, there were fewer than 8 million babies born in 2025, the lowest number since 1949 (source: Asia Times). India has now surpassed China as the world’s most populous country. An aging and declining population puts stresses on the pension system, and as the working-age population decreases, economic growth—on which the entire legitimacy of the Chinese Community Party depends—is also negatively impacted.
Forecasting the Future
While several of these problems have been described or spoken about at least since the global financial crisis in 2008-2009, looking at how the government is reacting can often reveal more than what official pronouncements, statistics and anecdotes can. Since Xi Jinping was elected to the post of general secretary of the Communist Party of China (CPC) and chairman of the CPC Central Military Commission in 2012, he has gradually consolidated more authority and created something of a personality cult around himself. One key reform was the elimination of the two-term limit for president, essentially allowing him to be president for the rest of his life. In addition, China has imposed an internet firewall and monitors online chats and cell conversations, thereby creating a strong surveillance state. These efforts have been ongoing for many years.
What is relatively new, however, is that President Xi appears to be purging the military and the elite. China’s 7-person supreme military leadership body has currently been reduced to two individuals (Xi and one other person) (Source: Reuters). While Xi has launched several anti-corruption drives over the last few years, it has been presumed that much of this is aimed at removing political rivals as much as it has been about corruption. While military significance of these removals remains to be seen, it will be interesting to see if the empty seats on the commission are filled. Recent years have shown Xi tightening his grip, including the shocking scene at the 2022 National Congress of the Chinese Communist Party when former Chinese leader Hu Jintao (seated next to Xi) was physically led out of the hall (something reminiscent of Saddam Hussein purging his enemies within the Baath Party in the late 1970s). Other high-level officials have been removed and apparently not replaced, as evidenced by the empty seats that are now noticeable at official events (Source: Jerusalem Post).
While there are many opinions on what this might mean, much of the commentary focuses on what it means for the ability of the Chinese military to launch an attack on Taiwan in the near future. But even more important is what it could mean for the stability of the regime. While some have stated that the purges indicate a paranoid leader seeing treason around every corner (possible), others say that it is sign of Xi’s confidence in himself and that he feels secure enough in his position to make these moves (also possible).
What is likely though, assuming that Xi does not fill these positions, is that his knowledge and understanding of China and the world is likely to be constrained. And even if these positions are filled, they are likely to be filled with yes-men instead of professionals who can take action or tell Xi things that he does not want to hear. This often creates a bubble around a leader, which can skew their perspective and hamper them from taking actions that would produce positive outcomes.
Overall, many of the developments in China have continued down the path that many were discussing 10 years ago. While one can only guess at Xi’s thought process, the purging of trusted advisors is more often a sign of insecurity rather than overconfidence. With indications that the population may be losing some faith in the banking system due to zombie loans/companies, the instability in China has already risen to much higher levels than before the pandemic. While nobody can say when or how the political unraveling of Xi (and very possibly the Chinese Communist Party rule) will occur, unravelings of this sort can often happen suddenly and seemingly from out of nowhere. The long-time ruler of Romania, Nicolae Ceaușescu, felt secure enough to go to Iran on a state visit, and yet barely a week later was overthrown, put on trial and executed.
Nobody is saying this will happen in China; however, panic buying of silver is an indication that the population is losing faith in the solvency of banks, and a loss of faith in banks is an indication of a loss of faith in the promise of prosperity, which is the promise underpinning the legitimacy of the Chinese Communist Party, which takes the population’s freedom but offers them prosperity in exchange. The purges that have taken place have removed people who were formerly part of the elite and had a stake in the existing governing system and turned them from insiders to outsiders, which has likely turned them against the system. While some are concerned that Xi may start a war with Taiwan (or another country) to enhance the popularity of the regime, his purging of the military is likely to be disruptive enough that it may not be in a solid position to conduct a serious war in the short run—at least not until the disruption caused by the various moves has stabilized.
There is a possibly apocryphal story of an individual who, when asked how he went bankrupt, responded, “For a long time very slowly, and then suddenly.” With the pressures building in China, the measurable loss of confidence and the purges that may be creating enemies of the system as well as possibly isolating Xi in an information bubble, thereby skewing his perception of events, a sudden break and unraveling of the system cannot be ruled out.
References:
- China debt overhang leads to rising share of ‘zombie’ firms - Dallasfed.org
- Chinese property sector crisis (2020–present) - Wikipedia
- Silver Smashes All-Time Highs Near $111 As China's 'Zombie Banks' Spark Metal Rush—Is It Generational Trade Or A Bubble?
- China’s demographic crisis has moved from theory to fact - Asia Times
- Population by Country (2026) - Worldometer
- China's Xi makes rare public reference to recent military purges | Reuters
- Xi’s purges reshape China’s military and power structure | The Jerusalem Post
