Money is lent on concessionary terms to make transactions happen for politically favored businesses and investors on the theory that the resulting economic activity will be worth the costs. And it’s fairly easy to get away with that arrangement, because the costs are disguised as profits: A loan made at a below-market rate is a wealth transfer, but in the government ledger it looks like income. Simple example: If the U.S. government were to lend me $1 billion for 20 years at 1 percent interest, I’d be a very, very happy man, and even if I earned only modest returns on that $1 billion, I’d have around $1 billion in my pocket after paying back the original loan. In effect, the government would have given me $1 billion, but on the books it would look like it had instead earned more than $100 million in 20 years. That’s because government is accounting only for the interest I paid, not the interest it could have earned if it had lent the money at the market rate.
I know myself well enough to predict that I’d do some jackass things with that $1 billion. And China has financed some jackass adventures, too. The ghost cities are the most famous, but Beijing has also underwritten the construction of a great many factories that don’t produce economically viable goods and has used cheap credit to prop up enterprises and industrial sectors that are not genuinely productive or competitive. The thinking here will be familiar to those of you who have followed the various stimulus-package debates in Washington over the years: Sure, that cheap money may be contributing to overbuilding, but it creates a lot of jobs in construction, and it jacks up demand throughout the economy by increasing the domestic appetite for steel, cement, construction supplies, machinery, etc. The guy at the cement factory gets a raise, his family gets more noodles or a new motorscooter, the multiplier effect kicks in and presto-change-o, you’ve made yourself wealthier by throwing money away. Which in fact works pretty well, until it doesn’t. Eventually the Chinese government, despite all its tanks and brutality and nuclear weapons and gulags, must bow before Stein’s Law: “If something cannot go on forever, it will stop.”
China’s current economic reversal is being driven in part by a slowdown in construction. As it turns out, if you build enough ghost cities full of empty apartment blocks, then the oversupply in the market eventually makes it unprofitable to build more empty apartment blocks. (Counterintuitive, right?) Students of Austrian economics will recognize this as the old problem of “malinvestment,” capital’s being misallocated because of subsidies and other distortions. Who’d they build those apartment towers for? Who cares? If there’s free money on the table, somebody is going to pick it up.