China is facing the most serious economic challenge of its modern history, as the ongoing collapse of the real estate market has triggered an unprecedented debt crisis, revealing the fragile foundation upon which the Chinese miracle was built. Today, the debts of the local governments and their financing vehicles LGFV have skyrocketed to 134 trillion yuan, that is 18,9 trillion dollars, one of the highest levels of public debt in the world.
For the first time in decades, China cannot buy time with the old recipe of massive credit expansion. Debt has already reached levels that threaten its fiscal and financial stability. The question now is not whether there will be a crisis, but how big it will be and when.
The collapse of the real estate market and the end of the Chinese growth model
The five year slump in the real estate market shows no signs of recovery. The failure of Vanke, the last major state supported real estate company, confirms that the sector is in systemic crisis, not in a temporary correction. Land sales, the main revenue source of local governments, collapsed from 8,7 trillion yuan in 2021 to only 3 trillion yuan in 2025. More than 10% of available properties do not receive even one offer, a fact that underscores the collapse in demand. When land buying stops, local development financing stops as well. From there begins the largest explosion of fiscal debt in the history of China.
Record debt and unrestrained bond issuance
Local governments are rushing to plug the holes with new borrowing. The issuance of local bonds has already exceeded 10 trillion yuan, breaking every previous historical record. The total outstanding balance of local bonds has reached 54 trillion yuan, while the hidden debts of LGFV are estimated at 87 trillion yuan. In other words, almost half of China’s GDP is concealed in shadow debts outside official Chinese statistics.
The most worrying aspect is that the LGFV are not functional. Only 3% show returns above 4%, while almost 10% are loss making. In 2024, the LGFV received more than 1 trillion yuan in subsidies, an amount more than double their profits. Practically, without liquidity injections from Beijing, the entire mechanism would have collapsed.
Deflation and low interest rates
The People’s Bank of China PBOC is trying to keep the system alive through record low interest rates and massive liquidity. The average yield of LGFV bonds in Beijing has fallen to 2,1%, a level reminiscent of Japan in the era of negative interest rates. But deflation, which at first looks like debt relief, evolves into fiscal poison. Nominal growth is tumbling to 3%, approaching dangerously the borrowing rates and breaking the so called Domar Condition, the fundamental criterion of debt sustainability. When nominal growth does not exceed the cost of borrowing, debt inflates uncontrollably.
If the PBOC does not adopt negative interest rates and aggressive quantitative easing, the debt crisis will worsen rapidly.
Beijing buys time
Facing the danger of systemic collapse, the Xi government continuously approves new support packages. In October, the Ministry of Finance announced a new 500 billion yuan program, while the government gave the green light for a new issuance of 10 trillion yuan in local securities, transferring the LGFV debts to the municipalities. But this tactic is a fiscal patch, it shifts the problem from one side of the balance sheet to the other without restoring sustainability.
Capital controls, export of deflation
China maintains three artificial defenses, strict capital controls, a massive trade surplus and state directed credit supply. According to Michael Every of Rabobank, this strategy is not from a position of strength but from absolute necessity. China must continue exporting deflation because its internal economy is incapable of absorbing the scale of the debt.
However, international demand is slowing, foreign exchange reserves are under pressure and the ability of Beijing to control all variables is declining.
What will happen when China can no longer finance itself
The China of 2025 is not the China of 2008. It is no longer the global savior of a new wave of growth but the largest systemic risk to the global economy. With a real estate market that resembles the United States before 2007, a Japanese style fiscal debt trap and deepening deflation, Beijing is walking a thin line, trying to prevent a Lehman 2.0. This time, in contrast with 2008, there will be no China to save the world.
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