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Eventually, this sort of problem generally gets solved with government bailouts. The government simply borrows or prints money, buys the bad debts, and takes a fiscal hit. This cleans up bank balance sheets and corporate balance sheets, and makes everyone feel safe about borrowing and lending again.

In China, this effort has begun - the central government is beginning to bail out banks and local governments , and is considering bailing out big property developers too. If that were the only thing going on, it would probably turn a“lost decade” into a four-year slump like the one America experienced after the crisis of 2008.

But that isn't the only thing that happened. China's government also tried to sustain growth through this difficult period by ordering banks to make a new giant wave of loans - this time to manufacturers. A lot of those loans ended up going to property-related stuff , which probably didn't help.

But a lot went to manufacturing - along with truly massive amounts of government subsidies, as part of the government's push for China to be the world's dominant high-tech manufacturer. If you count both subsidies and the benefits of ultra-cheap loans, China's industrial policy push might total 4.4% of GDP .

The problem was that - as Japan's MITI bureaucrats from the 1970s could have told you - when you pay a ton of different companies to manufacture the same stuff, they end up competing each other's profits out of existence .

This is called“involution”, or 内卷 in China.[2] It's a problem for several reasons. First, it's a case of capital misallocation on a grand scale . No one in China really needs that many EVs and humanoid robots and whatnot, and the world market is getting saturated (where it's not actively blocked by tariffs).

So China's total factor productivity - its ability to make stuff that people actually want - is being held back. Also, despite China's much-publicized push into academic science, most of China's R&D is still done at the corporate level - and if corporations have no profits, they have no way to invest in new technology, even if doing so would be useful in the long run.

Those are the microeconomic problems of involution. But there are also two big macroeconomic problems. First, if you force your economy to over-produce, you get deflation. China continues to experience falling prices .

Falling prices mean companies and banks and local governments have reduced ability to pay back their debts. This is called debt-deflation , and it's exacerbating China's attempts to bail out its real estate debt.

On top of that, China's huge burst of hastily made industrial loans is piling up more bad debts in the system. Even though industrial loan growth has slowed sharply (as everyone in China realized that many of those investments were going to get competed out of existence), China's total debt-to-GDP ratio has kept on rising relentlessly .

Eventually, many of the car companies and solar companies and robot companies that China's government told its banks to lend to will go bust, and this will leave another mountain of bad loans on the books, on top of the leftover mountain from the real estate crash. And this time, there's no obvious sector that the government can pump up lending to in order to keep the party going.

So unsurprisingly, China's government is trying to rein in overcompetition, much as Japan's government did in the 1970s. Basically, the solution is going to look like price fixing - telling companies not to compete by cutting prices[3] :

This could help with the deflation problem a bit. But it will tend to exacerbate the capital misallocation problem. Essentially, instead of simply cutting off the subsidy tap to the failing companies and letting the successful companies acquire them and fire half of their workers (which is what the typical theory of industrial policy says you should do), China may simply end up allowing a bunch of inefficient companies to stay in business. That could hurt long-term productivity, as it probably did in Japan.

The problem is that if China does allow its bad companies to fail, a lot of Chinese people are going to be out of a job, which could increase unrest. China's labor market is already hurting , so the government is very sensitive to this.

Source: Bloomberg via Noahopinion

An added wrinkle is that, unlike Japan or Korea, China is a very large country with a highly federalized governmental system. This means each province has its own local champion companies, meaning that if Beijing lets a bunch of inefficient companies die, it'll hurt some provinces a lot more than others. This could increase political instability, meaning China has even more incentive to let“zombie” companies stick around than Japan did in its day.

So China is in a bit of a macroeconomic bind. It can't easily stop its industrial policy, but continuing it means mounting costs - exacerbated by the legacy of the real estate bust. This could end up causing a multi-decade drag on China's productivity, like similar problems did for Japan.

But this wouldn't represent a collapse for China, or even a fall from its peak. When Japan went from 95% of US living standards to 61%, it meant becoming an economic also-ran. But China is four times the size of the US, so a similar slowdown in its economic trajectory would still leave it with much more economic heft than its biggest rival.

Recall that the USSR - that famous economic basket case - had 30% of America's per capita GDP. If the Soviet Union had been four times America's size, its economy would have been 1.2 times as large, and the Cold War might have gone very differently.

In other words, China's economic problems are a reason to think its peak might underwhelm, but that's worlds away from causing it to fall off its perch.

War and internal dissent

If the slow, peaceful processes of demographics and economics aren't going to stop Chinese dominance anytime soon, that leaves the more violent threats of war and internal dissent. In fact, these are the things that normally cut short a great power's moment in the sun - Germany and Japan are only the most recent examples.

France bit off more than it could chew militarily in the 1700s and early 1800s, as did Spain in the 1600s. The Tang Dynasty and the Mongol Empire were torn apart by internal dissent, and so on. Even America's current decline is due mainly to internal divisions, as Abraham Lincoln predicted .

So what about China? Until Trump's election, the notion that China would run into a military coalition it was unable to overcome was at least somewhat plausible. China's main allies, Russia and North Korea, are militarily fierce but not economically strong.

Together, an alliance of the US, Europe, India, Japan and Korea might have been able to take down China's New Axis, especially if the US had implemented policies to rapidly reindustrialize itself and build up India's technological and manufacturing capabilities.

Now, this is looking a lot less likely. The Trump administration seems dead-set on alienating Europe , India , and Korea . There are strong signs that Trump wants to abandon involvement in the Eastern Hemisphere in order to focus on domestic conflicts (immigration and suppression of political dissent). On top of that, Trump has sacrificed industrial policy in favor of tariffs that simply hurt American manufacturing.

This doesn't mean China is going to be able to conquer the world. But it does mean the world will no longer be able to conquer China.

Which leaves internal dissent as the main threat to China's moment in the sun. In a post a few months ago, I speculated that as Xi Jinping ages, dissatisfaction with his lack of policy competence may cause him to crack down harshly . I recently wrote:

It would be incredibly stupid and self-destructive for China to fall into destructive political infighting right at the very peak of its relative power and wealth. But it wouldn't be the first time, as the aforementioned examples of the Tang Dynasty and the Mongol Empire show. In a way, Europe cut short its peak as well, with World War 1, when cooperating to manage the global system of European empires would have extended their dominance.