The Next 100 Years

Rome
Rome
Constantinople
Constantinople
Samarkand
Samarkand
Bukhara
Bukhara
Merv
Merv
Tyre
Tyre
Rome
Constantinople
Antioch
Samarkand
Bukhara
Merv
Dunhuang
Bactra
Kabul
Hotan
Xian
Tashkent
Kashgar
Tyre
Palmyra
Alexandria
Silk Road
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The coastal regions again became prosperous and closely tied to outside 
powers. Inexpensive products and trade produced wealth for the great 
coastal cities like Shanghai, but the interior remained impoverished. Ten­
sions between the coast and the interior increased, but the Chinese govern­
ment maintained its balance and Beijing continued to rule, without losing 
control of any of the regions and without having to risk generating revolt by 
being excessively repressive. 
This has gone on for about thirty years, which is not very long by any 
standard (and certainly not by Chinese ones). The open question is whether 
the internal forces building up in China can be managed. And this is the 
point at which we begin our analysis of China and its effect on the interna­
tional system in the twenty- first century. Will China remain part of the 
global trading system? And if it does, will it disintegrate again? 
China is gambling at the beginning of the twenty- first century that it 
can carry out an indefinite balancing act. The assumption is that it will be 
able to gradually shift resources away from the wealthier coastal regions 
toward the interior without meeting resistance from the coast and with­
out encountering restlessness in the interior. Beijing wants to keep the vari­
ous parts of China happy and is doing everything in its power to achieve 
that end. 
Underlying this is another serious, and more threatening, problem. China 
appears to be a capitalist country with private property, banks, and all the 
other accoutrements of capitalism. But it is not truly capitalist in the sense 
that the markets do not determine capital allocation. Who you know counts 
for much more than whether you have a good business plan. Between Asian 
systems of family and social ties and the communist systems of political re­
lationships, loans have been given out for a host of reasons, none of them 
having much to do with the merits of the business. As a result, not surpris­
ingly, a remarkably large number of these loans have gone bad—“nonper­
forming,” in the jargon of banking. The amount is estimated at somewhere 
between $600 billion and $900 billion, or between a quarter and a third of 
China’s GDP, a staggering amount. 
These bad debts are being managed through very high growth rates 
driven by low- cost exports. The world has a huge appetite for cheap exports, 
and the cash coming in from them keeps businesses with huge debts afloat. 

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But the lower China sets its prices, the less profit there is in them. Profitless 
exports drive a giant churning of the economic engine without actually get­
ting it anywhere. Think of it as a business that makes money by selling 
products at or below cost. A huge amount of cash flows into the business, 
but it flows out just as fast. 
This has been an ongoing issue in East Asia, and the example of Japan is 
instructive. Japan during the 1980s was seen as an economic superpower. It 
was devastating American businesses—MBAs were being taught to learn 
from the Japanese and emulate their business practices. Certainly Japan was 
growing extremely rapidly, but its rapid growth had less to do with manage­
ment than with Japan’s banking system. 
Japanese banks, under government regulation, paid extremely low inter­
est rates on money deposited by ordinary Japanese. Under the various laws, 
the only option for most Japanese was to put money into Japan’s post office, 
which doubled as a bank. The post office paid minimal interest rates. The 
government turned around and lent this money to Japan’s largest banks, 
again at interest rates well below international levels. These banks lent it 
again cheaply to businesses with which they were linked, so Sumitomo 
Bank loaned the money to Sumitomo Chemical. While American compa­
nies were borrowing money at double- digit rates in the 1970s, Japa nese 
companies were borrowing money at a fraction of that amount. 
It was no surprise that Japanese businesses did better than American 
ones. The cost of money was much lower. It is also no surprise that the 
Japanese had extremely high savings rates. Japan had virtually no public re­
tirement plan at the time, and corporate pensions were minimal. Japanese 
planned for retirement through savings. They weren’t more frugal, just more 
desperate. And this pool of desperate depositors had no alternative but to 
make deposits at very low interest rates. 
While high interest rates imposed discipline on Western economies, 
culling out the weaker companies, Japanese banks were lending money at 
artificially low rates to friendly corporations. No real market existed. Money 
was flowing and relationships were the key. As a result, a lot of bad loans 
were made. 
The primary means of financing in Japan was not raising equity in the 
stock market. It was borrowing money from banks. Boards of directors con­

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sisted of company employees and bankers who were not interested in profits 
nearly as much as they were in cash flow that would keep their companies 
afloat and pay off their debts. So Japan had one of the lowest rates of return 
on capital in the industrialized world. But it had a fabulous growth rate in 
terms of size because of the way the Japanese structured their economy. 
They lived by exporting. 
The Japanese had to. With an extremely high savings rate driving the 
system, average Japanese citizens were not spending money, and therefore 
Japan could not build the economy on domestic demand. And since Japa ­
nese companies were controlled not by investors but by insiders and bankers, 
what they wanted to do was increase the cash coming in. How much, if any, 
profit was generated mattered less. Therefore, low- cost exports surged. More 
money was lent, more cash was needed, and more exports were sent out. 
The economy grew. But underneath it, a crisis was brewing. 
The casual ways in which Japanese banks made loans increased the num­
ber of nonperforming loans—loans that were not being repaid. A lot of bad 
ideas were funded. Rather than write these off and let the businesses in­
volved go into bankruptcy, Japanese banks covered up with more loans to 
keep the companies alive. Loans surged, and since depositors’ money was 
spent maintaining the system, exports to bring in even more money were es­
sential. The system was awash with money, but underneath it a vast array of 
companies on life support—and companies struggling to increase cash 
without regard for profit—were undermining the entire financial system. 
Massive surges in exports were producing very little profit. The entire sys­
tem was churning just to keep itself afloat. 
From the outside, Japan was surging, taking over markets with incredi­
ble products at cheap prices. It was not obsessed with profits like American 
firms were, and the Japanese appeared to have a hammerlock on the future. 
In fact, the opposite was true. Japan was living off a legacy of cheap, 
government- controlled money, and low prices were a desperate attempt to 
keep the cash coming in so the banking system would hold together. 
In the end, the debt structure grew too massive and it became impossible 
to stay in front of it with exports. Japanese banks began to collapse and were 
bailed out by the government. Instead of permitting a massive recession to 
impose discipline, Japan used various salvaging means to put off extreme pain 

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in return for a long- term malaise that is still lingering. Growth plunged, 
markets plunged. Interestingly, while the crisis hit in the early 1990s, many 
Westerners did not notice that the Japanese economy had failed until years 
later. They were still talking about the Japanese economic miracle in the 
mid-1990s. 
How is this relevant to China? China is Japan on steroids. It is not only 
an Asian state that values social relations above economic discipline but a 
communist state that allocates money politically and manipulates economic 
data. It is also a state in which equity holders—demanding profits—are less 
important than bankers and government officials, who demand cash. Both 
economies rely heavily on exports, both have staggeringly high growth rates, 
and both face collapse when the growth rate begins even to barely slow. 
Japan’s bad debt rate around 1990 was, by my estimate, about 20 percent of 
GDP. China’s, under the most conservative estimate, is about 25 percent— 
and I would argue the number is closer to 40 percent. But even 25 percent 
is staggeringly high. 
China’s economy appears healthy and vibrant, and if you look only at 
how fast the economy is growing, it is breathtaking. Growth is only one fac­
tor to examine, however. The more important question is whether such 
growth is profitable. Much of China’s growth is very real, and it generates 
the money necessary to keep the banks satisfied. But this growth really does 
not strengthen the economy. And if and when it slacks off, for example be­
cause of a recession in the United States, the entire structure could crumble 
very fast. 
This is not a new story in Asia. Japan was a growth engine in the 1980s. 
Conventional wisdom said it was going to bury the United States. But in re­
ality, while Japan’s economy was growing fast, its growth rates were unsus­
tainable. When growth slumped, Japan had a massive banking crisis from 
which it has not really fully recovered almost twenty years later. Similarly, 
when East Asia’s economy imploded in 1997, it came as a surprise to many, 
since the economies had been growing so fast. 
China has expanded extraordinarily for the last thirty years. The idea 
that such growth rates can be sustained indefinitely or permanently violates 
basic principles of economics. At some point the business cycle, culling 
weak business, must rear its ugly head—and it will. At some point a simple 

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lack of skilled labor will halt continued growth. There are structural limits 
to growth, and China is reaching them.