Japan's "day of reckoning" already came: what they've been in for the last 25+ years is the "post-reckoning" of ZIRP, low growth and low inflation. If the Chinese debt bubble explodes, it's not like the country is going to collapse, the most common prediction is that they'll become "Japan 2.0" where the country is functional but trapped in anemic growth because they won't let zombie businesses fail.
It's quite tragic.
What appeals to me about Pettis's analysis is it's rooted in a simple quantitative model that rests on accounting identities. When you've got a model that fundamental, it's easier to make strong predictions.
Also, "markets being irrational" is a claim about asset bubbles. What we're discussing here is much larger, and subject to its own laws of dynamics. It's not a bubble, per se -- it's more like a bad loan that keeps getting rolled over and bigger, and no one acknowledges the loan won't be repaid. Someone is going to lose out, but the day you can't cover the interest payments is the day you have to acknowledge the loss.
In the case of China in 2017, the debt is held by banks, who are functionally insolvent if the bad loans (usually to property developers and commercial entities) were called in. Many of these commercial entities (large, state-owned enterprises, or state-adjacent conglomerates) simply have no possible way to service the actual loans, short of rolling over more debt.
This isn't about asset prices, or a bigger fool bidding up the price of, say, housing stock: it's about the ratio of debt to productive capital. And the reason debt ballooned post 2008 is because the regular investment engine (mostly infrastructure and housing) had started to lose steam. The growth in debt in the economy was a rational response to the need to keep growth numbers high.
But deferring the reckoning doesn't make it better. Though it's held in the corporate sector, much of China's debt behaves almost like revolving consumer credit in the US.
(Also: one form of reckoning is flat growth for an extended period of time; Japan's lost decade is entering its third decade now, and systemic debt is still really bad. Pettis holds up Japan as one example of how not to correct the imbalances.)
But I'd hardly describe that as a "reckoning". It sounds more like a predictable "regression to the mean"
China's unprecedented growth is unsustainable; people know this. Case in point: this article.
We saw the bust in the early 90's.
And yet when I read things like this I also think of the cliché, "Markets can remain irrational longer than you can remain solvent."
People have been waiting decades for Japan's post-boom day of reckoning and we've not seen it.