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China's Dangerous Debt

Why the Economy Could Be Headed for Trouble

Priced out: construction in Changzhi, March 2012 Reuters / Stringer

In September 2008, when Chinese President Hu Jintao got word that Lehman Brothers, then the fourth-largest U.S. investment bank, was on the verge of bankruptcy, he was traveling by van along the bumpy roads of Shaanxi Province. Surrounded by policy advisers and members of the Politburo, Hu asked them how China should respond to the inevitable spillover. According to one participant in the discussion, the group reached a clear consensus by the trip’s end: China would need to launch a massive stimulus program. And it could trust only state-owned enterprises (SOEs), rather than private firms, to carry it out.

That November, as other governments were still debating what to do next, Beijing announced that it would distribute nearly $600 billion in stimulus funds to SOEs and other institutions, principally to fund ambitious infrastructure and industrial projects. Banks began lending generously, and local governments rushed to form shell SOEs that would

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