A Central Bank With Chinese Characteristics (iii)

How does the Chinese economy actually blow up?

Hi again! It’s Sunday, which apparently means I have little better to do than reappear with Part Three of this series about the Chinese central bank. And just to remind you:

• Part One: What does the People’s Bank of China do?

• Part Two: What tools does it have to do this?

• Part Three: What does the People’s Bank of China do if/when the Chinese economy collapses?

• Part Four: How do the US, European and Chinese economies actually collapse?

So if Part One explained what the PBoC actually does, and Part Two showed how money actually moves through China’s financial system, then Part Three finally answers the question everyone really cares about:

What happens when things go wrong?

What does the PBoC do when the Chinese economy looks like it’s falling off a cliff?

Because yes, of course things do go wrong in China. All the time. And when they do, the way the system responds is so wildly different from the West that us Westerners continually misread what’s happening, panic, scream “Lehman moment!” and then… discover a year later that China didn’t collapse after all. (Evergrande, cough cough).

So this final part is about the systemic pressure in China: where it builds, why it builds, and how the CCP stops that pressure from blowing the system apart!

In particular, I want to look at the three main ways in which the proverbial shit could hit the Chinese fan… (i) property sector; (ii) local governments; and (iii) the Chinese currency.

Shit Show One: Property

Let’s start with the big one: property.

So, China’s property sector isn’t just large, it is practically the gravitational centre of the Chinese financial universe! And there are a few reasons for this, none of which resemble anything that we can comprehend in US or European terms.

Firstly: household wealth.
In China, over 70% of household assets sit in property. Not stocks or pensions. Property. When you buy a home in China, it’s not just a place to live. It’s your savings account, your retirement plan, your inheritance for your kid, your insurance policy… everything. (Actually, if you’re Irish, this may be similarly comprehensible!).

Second: government revenue.
In China, the financial stability of local governments relies heavily on land sales to developers. Weird, I know. Basically, when property developers buy land, the local government gets paid. When they don’t? Nada. Local finances wobble. (Hold this thought for a bit later when I discuss LGFVs again!)

Third: bank collateral.
Chinese banks (especially state banks) hold tons of mortgages and developer loans. So if the property sector gets jittery, the entire banking system starts to implode at once.

Fourth: construction = jobs.
A slowdown in property doesn’t just hit developers! It hits construction workers, steel producers, cement makers, electrical equipment factories, and roughly ten thousand other industrial supply chains China depends on.

So… When property comes under pressure, China has a really fucking big problem on its hands.

And of course, we’ve already seen this play out. Repeatedly. Evergrande being the most dramatic example! But here is the crucial thing Western analysts get wrong nearly every single time:

A Chinese property crisis is not a Western-style property crisis.

Because when property goes tits up in the West, it’s usually because markets freak out, banks freeze lending, and before anyone can even locate the “liquidity facility” menu option at the Fed, everything is already on fire and burning down.

China is different. China does managed failure.

Meaning that when a developer like Evergrande implodes, everyone in the Western financial press begins dry heaving into their laptops, screaming: “This is it! This is the collapse! China is finished!”

Meanwhile in Beijing, as I mentioned in Part Two:

• The PBoC makes sure banks still have enough liquidity.

• Mortgages continue to flow so regular families aren’t punished.

• Construction on unfinished homes keeps going so homebuyers aren’t stranded.

• Healthy developers get just enough support to keep breathing.

• And the worst, most reckless developers are left to die in the corner (wow! 2008, are you listening?!).

So: China amputates the infected leg but keeps the patient alive. And this model… makes sense.

In case you’re wondering, the Western system does the literal opposite. It tries to treat the infection with vague hand-waving while the patient bleeds out on the table.

In China’s logic, developers failing is fine. However, systemic failure is not.

And as I said in Part One and Two, this is where the PBoC shows its real power, not by preventing crises, but by managing them so they don’t spread!

Shit Show Two: Local Government Debt (LGFVs)

Honestly? This one is even more chaotic than property: local government debt, also known as the LGFV circus.

So here’s the situation, as mentioned in Part Two: China’s local governments build everything. And I mean everything! (E.g. metros, airports, highways, sewage systems, industrial parks, science zones, rail lines, entirely new cities that may or may not have been necessary…)

But we also know: local governments in China cannot actually borrow money because of how badly they behaved when given access to the piggy bank before!

And thus, the Local Government Financing Vehicle (the LGFV) does this for them. Big time.

But what happens when these LGFVs (which are private companies, remember!) get into trouble? Oh boy.

Here is exactly what stress looks like:

• LGFVs can’t roll over their debt anymore (never ideal)

• Land sales collapse because developers stop buying land (remember I told you: land sales is how local governments finance everything!)

• Regional banks panic because they lent heavily to (you guessed it) LGFVs

• Entire provinces begin drifting into quiet, unspoken, near-insolvency, with the local politicians hoping the Party does not find out (yes, the punishment for insolvency is dire).

Cue Western analysts, yet again: “This is it! Municipal bankruptcy! Mass defaults! Contagion meltdown!”

Cue Beijing: “Calm the fuck down.”

Because once again, China does managed failure, not Western-style chaos. Contagion is not part of its model!

So what does managed failure look like in the LGFV world?

• “Bond swaps” to extend repayments by 5–10 years (kick the can down the road)

• Restructuring of the worst LGFVs (surgical but real)

• Targeted liquidity to regional banks (so nobody tips over)

• Discreet fiscal transfers from Beijing (no bailout headlines, please)

• Merging or shutting down the most problematic LGFVs

• Temporary shadow financing allowed so projects don’t stall

And absolutely, under no circumstances: no formal municipal bankruptcies! Because public default = social instability = political risk = not happening. And this, incidentally, is why it’s nearly impossible for the West to comprehend what is actually happening inside China, given how curated (read: half-truthing) the official statements ever are.

From the outside, this obviously looks messy, opaque, and sometimes absurd. But from the inside, it’s a slow-release pressure valve, doing exactly what it says on the tin.

So if property crises taught us China amputates limbs to save the body, LGFVs teach us that China depressurises the entire system before the boiler explodes.

Shit Show Three: Currency

This is the one topic that sends Western analysts into a full meltdown every few months, including, at times, even me.

So, building on everything from Part Two:

China’s currency (the renminbi, measured in yuan) isn’t just an exchange rate. In fact, it works more like a signal for the whole economy.

Of course, in every country a currency reacts when the economy changes. But in China, those movements mean something different because of how the whole system is built.

In the West, the exchange rate is just a market price: one of many, and often ignored domestically (because if the dollar weakens or strengthens within normal bounds, the price of your Big Mac doesn’t seem to change!). But in China, the yuan behaves like a system signal that policymakers actively use to understand and control capital flows.

If people get nervous, or money starts leaving the country, or exports slow down, the yuan moves, and Beijing immediately takes notice.

The point isn’t that the price changed; it’s that the movement tells them that something in the economy is under pressure!

This is why China doesn’t just let the yuan float around and hope for the best, kind of like we do in the West. So if the yuan jumps or drops too fast, it’s not “investor sentiment”, it’s a sign that policymakers are about to make a decisive move!

Again, let’s look at what “stress” actually looks like here!

• The RMB weakens more than Beijing would like (Booo! Bad).

• Capital outflows start to rise (remember: this is equivalent to people voting with their wallets!)

• Corporates begin hoarding dollars like a downturn is coming.

• Wealthy households suddenly show great enthusiasm for buying property in London or sending their kids to school in Switzerland.

• Everyday people look for increasingly creative (read: illegal) ways to get money out of the country. (Side notes: try to look some of these up; they’re ingenious!)

Cue Western commentators, yet again: “This is it! Currency collapse! Mass devaluation! Market panic!”

Cue Beijing: “Shut the fuck up.”

Because (say it with me!) China does managed failure, not Western-style chaos. And uncontrolled capital flight out of China simply is not part of its model. It is just not tolerated in China!

So what does managed failure look like in the currency world?

• State banks are told to buy RMB and sell USD (yes, they can literally do this on command).

• Capital controls tighten (suddenly, moving money abroad becomes… “difficult”).

• Exporters are “nudged” to convert some of those juicy dollar earnings into RMB ( ;))

• Corporates are “discouraged” from dollar-hoarding (with a soft whisper of “we’re watching you”).

• Outbound channels shrink. Tourism quotas, bank transfers… all tightened.

• The offshore RMB becomes too expensive to short, and speculators get absolutely slapped!

And magically? The panic stops, and the RMB stabilizes, and everyone pretends nothing happened.

And once again, here’s the part that’s misunderstood in the West:

The RMB cannot “collapse” the way Western currencies can because China simply does not allow the flows that cause collapses!

Now, this does not mean that China’s economy cannot experience a downturn. Au contraire. But it simply means that China’s system is engineered to prevent the kind of sudden, violent capital movements that wiped out multiple Asian economies in 1997, brought Argentina to its knees, and dusted Turkey’s currency multiple times. (Incidentally, all the kind of financial events that my But This Time It’s Different co-partner Alex loves!).

And unlike the fucking crazy self-created mandate of the Fed and ECB, the PBoC’s job is not to stop pressure from ever appearing. Rather, it’s to make sure the pressure never blows the whole thing up.

(Remember isolating during covid? This was the same! The point wasn’t to “never catch covid”, but rather to slow down the transmission so that hospitals could cope!).

Which is why, every time a Western commentator screams “THE RMB IS GOING TO ZERO,” China issues a bizarre statement about something entirely non-topical, adjusts a few state bank mandates, and moves on.

And so:

If property crises showed us that China amputates limbs to save the body, and LGFVs showed us China depressurises before the boiler explodes…

The currency makes it clear China controls its own financial borders! What flows in, what flows out, and at what speed.

Crash Test Dummies

Now that we know the three big issues in China (property, LGFVs, and the currency), I want to add a layer of complexity:

These pressures never appear in isolation!

In fact, like most economies, they behave like a complex system: linked, reactive, and constantly feeding back into one another. China’s response to this is not to treat them as separate fires, but as parts of the same network that must be managed together.

Think of it like this full chain reaction:

A property slowdown = weaker land sales = squeeze of LGFVs = stressed regional banks capital outflows triggered = pressure on the yuan.

But unlike in the West, where we are stupid enough to treat each part of the economy independently, and where nobody agrees whose job it is to respond, China treats this as one integrated problem. Hurrah!

And as such it deploys its three institutions (the PBoC, the Ministry of Finance (MOF), and the National Development and Reform Commission (NDRC)) like a crisis-management triad. (And no, not that triad).

• The PBoC handles the flow of capital: ensuring capital doesn’t freeze, banks stay liquid, and panic doesn’t spread.

• The MOF handles the fiscal holes: capital transfers, subsidies, discreet support, plugging holes without announcing such holes ever existed..

• The NDRC handles the economic redistribution: rapidly shifting investment, approving projects, rebalancing which sectors get pushed or pulled back.

So if property hits one part of the system, all three institutions adjust at once. Same for LFVGs and currency issues.

The point is that, once again, China doesn’t let crises spread freely! It channels them across institutions, catching and redirecting the pressure as it moves.

In the West, we kind of just hope and pray that crises won’t happen in the first place. Of course, China sensibly assumes they will, and builds fiscal and monetary structure around them.

Ok, So… Can the Chinese Economy Actually Blow Up?

Short answer: yes!

Longer answer: …but not in the way people imagine.

China isn’t going to wake up one morning and suddenly “Lehman Brothers” the fuck out of itself. That’s simply not how the system is built, as you should know by now. The real risk within China is not a dramatic explosion, but a situation where the entire point-and-shoot machine stops being able to channel and remove the build-up of pressure quickly throughout the system.

For the economy to truly “blow up,” several things would have to fail at the same time:

1. The pipes clog: capital stops flowing because banks hoard liquidity and refuse to lend, even when ordered (very unlikely that the bank will go against the Party!).

2. The currency firewalls crack: capital outflows move so fast that they overwhelm the currency controls, and people stop trusting the yuan en masse.

3. The triad misfires: the PBoC, the Ministry of Finance, and the NDRC stop coordinating, and policy becomes internally contradictory.

4. The social contract frays: economic growth stalls, jobs dry up, people lose faith, and the cost of holding everything together becomes politically unbearable. (Not impossible)

But it’s important to realize that none of these alone will collapse China. Like in any complex system, it’s the stacking that’s dangerous.

So barring a massive external shock (sanctions, war, embargo), the more realistic scenario isn’t a blow-up, it’s slow, shitty stagnation with the occasional controlled explosion (Evergrande 2.0?) safely redirected down one of the many pipes.

And this is really the heart of it:

China’s economy doesn’t avoid breaking, it avoids breaking all at once.

Every system has fault lines, and China simply chooses where they run. The trick isn’t to stop the cracks entirely. It’s to decide where they appear, how far they spread, and who absorbs them. That’s the philosophy of a managed crisis.

(It should also be very clear, by now, that the US does precisely the opposite of this, to its detriment!).

So instead of pretending that crises can be prevented (they can’t), it builds the tools to control their fallout..

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This series wasn’t just about the PBoC. It was about learning to see that the world’s second-largest economy isn’t the mirror image of the West with a few odd quirks, as it is often described! It’s a different species of system that has been built for speed, shock absorption, and political control… Not for transparency or market elegance.

And that matters.

Because how China handles its inevitable pressures of property, local governments, currency, shapes global trade, commodity cycles, capital flows, inflation, and geopolitical stability. Understanding its stress-responses isn’t an academic exercise; it’s a requirement for understanding the next decade!

China may not achieve breakneck growth again. It may stagnate, struggle demographically, and fight the drag of its own past choices. But collapse? Only if the political, monetary, and fiscal mechanisms fail together!