OF THE many things that are worrying investors around the world, from tumbling oil prices to the spectre of recession and deflation in Europe, one of the most important, and least understood, is China’s debt. For the past few years China has been on a borrowing binge. Its total debt—the sum of government, corporate and household borrowings—has soared by 100% of GDP since 2008, and is now 250% of GDP; a little less than wealthy nations, but far higher than any other emerging market (see article). Since most financial crashes are preceded by a frantic rise in borrowing—think of Japan in the early 1990s, South Korea and other emerging economies in the late 1990s, and America and Britain in 2008—it seems reasonable to worry that China could be heading for a crash. All the more so because the nominal growth rate, the sum of real output and inflation, has tumbled, from an average of 15% a year in the 2000s to 8.5% now, and looks likely to fall further as inflation hit a five-year low of 1.6% in September. Slower nominal growth constrains the ability of debtors to pay their bills, making a debt crisis more likely.

Reasonable, but wrong. China has a big debt problem. But it is unlikely to cause a sudden crisis or blow up the world economy. That is because China, unlike most other countries, controls its banks and has the means to bail them out. Instead, the biggest risk is complacency: that China’s officials do too little to clean up the financial system, weighing down its economy for years with zombie firms and unpayable loans.

Half of China’s debt is owed by companies, and most of that, in turn, is owed by state-owned enterprises and property developers. As the economy slows and housing prices fall, many of these loans will prove unpayable. Banks report that bad loans are just 1% of their assets and their auditors insist that the banks are not lying, but investors price banks’ shares as if the true level is closer to 10%.

Even if a huge swathe of loans go bad, the consequence is unlikely to be a Lehman-style financial collapse. For that, thank the Chinese regime’s vice-like grip on its financial system. Most lending is by state-controlled banks, much of it to state-owned companies. If it faced an economy-wide credit crunch, the government would (as it has in the past) simply order banks to lend more. At the same time the country’s vast foreign-exchange reserves mean China need not worry about a sudden drying up of foreign capital, the main cause of many other emerging-economy crises.

This combination of control and buffers gives China the time and headroom needed to tackle its debt problem. Unfortunately, it has also bred complacency. After all, officials began to talk about tackling debt in 2010. They have taken a few baby steps towards cleaning things up: a new budget law, taking effect next year, gives central authorities more power to oversee local governments borrowings. But, in practice, too many officials are content to see bad loans rolled over; too many prefer bail-outs to defaults. Earlier this year, amid much hoopla, Chaori Solar was the first Chinese company to default on a bond. This month its creditors were bailed out.

The long night of the living debt

This process—extending credit to failing and inefficient firms—creates a slow-burn debt crisis, marked by opacity and a misallocation of capital. Japan provides a depressing precedent. It failed to clean up after its asset bubble burst in the early 1990s, preferring to pretend that firms could pay their debts and banks were solvent. The result was zombie firms, ghostly banks and years of stagnation and deflation.

Beijing’s officials vow they will not repeat Japan’s malaise. To do that they must hold their nerve and let firms fail: a culture of bankruptcy should replace the lifelines and “evergreening” of useless loans. As long as investors think the state will cover their losses, they will plough money into dodgy schemes—and the problem will grow. Not only will that be a huge waste of money; even mighty China cannot cover losses for ever.