What's going on?

China�s economy has seemingly been on the rebound this year. But a lot of its growth was only made possible because Chinese companies borrowed a lot of money. Over the weekend, the International Monetary Fund (IMF), a major global financial organization, called China’s�high debt a �serious and growing problem.�

What does this mean?

The Chinese government encouraged companies to borrow money so that they would do things like buy iron ore and make steel with it, i.e. activities that (supposedly) boost economic growth. But if debt gets too large, it becomes a drag on the economy as companies spend so much of their money paying interest and repaying debt that they are unable to invest in future production. High debt, therefore, can lead to lower economic growth over time. It can also make the financial system more prone to a crisis� �

Why should I care?

For the market: Some investors say China�s high debt will trigger the next financial crisis. As we reported on Friday, billionaire investor George Soros thinks that China�s over-indebtedness will infect global markets. One possibility is that Chinese companies won�t be able to pay back a significant amount of the debt that Chinese banks have lent them � and the ensuing losses for the banks could cause a full-scale banking crisis (sort of like what happened in the US in 2008). However, other analysts counter that China�s current debt situation is more stable than America�s in 2008 and, even if there were problems, the Chinese government would have the tools to fend off a major crisis.

The bigger picture: Debt often causes short-term gain but long-term pain. Debt can be good: it allows companies to invest in new things that can ultimately make them more profitable. However, debt can also mask big problems. A perennially unprofitable company can stay alive as long as it�s lent new money to pay off its old debts. The challenge for any economy is to encourage lending to the companies that will use the money productively and to let the unprofitable companies go bankrupt without unduly harming the overall economy.