Thread by @izakaminska

THREAD: Why the private credit crisis is just the West’s version of “involution”

1/ In my latest piece for TBS I argue that the West's growing private credit crisis represents its own version of China's economic "involution" — a liquidity-driven form of economic growth that produces enormous activity and capital deployment but progressively weaker underlying returns.

2/ In China the mechanism was domestic financial repression. Cheap household savings were channeled into low-return industrial investment, producing massive overcapacity and exports sold abroad at razor-thin or even negative margins.

3/ In the West the mechanism looked different but produced a similar outcome. Extremely cheap capital and abundant liquidity fueled a private-equity, venture, and later private-credit ecosystem that allowed large numbers of structurally unprofitable firms to keep expanding.

4/ Many of these companies pursued scale at almost any cost. The idea was simple: give the product away, subsidize adoption, dominate market share, eliminate competitors, and worry about profitability later.

5/ The Silicon Valley / unicorn playbook therefore ended up mirroring Chinese industrial policy in an unexpected way: success depended less on near-term profits than on outlasting competitors through subsidized growth.

6/ But that dynamic rarely stopped once a winner emerged. New waves of venture-funded challengers constantly arrove trying to undercut incumbents, producing the same hyper-competitive environment seen in Chinese manufacturing sectors.

7/ In both cases the system starts to look less like normal price discovery and more like a quota-driven process where activity and expansion matter more than sustainable returns.

8/ Western markets reinforced this logic. For more than a decade investors overwhelmingly rewarded companies for growth rather than profits, allowing deeply unprofitable businesses to survive as long as revenues and market share kept expanding.

9/ That expansion was financed by private equity and venture capital backed largely by long-term investors like pension funds and endowments. Fund managers were rewarded primarily through valuation marks and paper gains, not realized cash returns.

10/ Over time private credit emerged as the refinancing layer that helped keep the system going — providing loans to companies traditional banks increasingly avoided while helping private equity preserve valuations and delay losses.

11/ The entire structure worked because liquidity was abundant and investors didn’t need immediate distributions. As long as capital kept flowing and valuations kept rising, the system could keep extending itself.

12/ If my analysis is correct then today's private credit turmoil isn’t really the cause of the problem.
Rather, it's a moment when a decade-plus of liquidity-driven involution collides with the need to produce real cash returns.

13/ Demographics are forcing that shift. Pension funds and other long-term investors are increasingly being drawn down to meet obligations, which means they now need actual cash flows, not just rising NAV marks.

14/ Once investors start demanding realizations, the illusion breaks. Companies that could survive indefinitely under abundant liquidity suddenly have to prove they can generate real profits and service real debt.

15/ The end result is classic involution: each additional unit of credit extended simply sustains or expands a loss-making business model, making the next round of growth even more expensive and less viable to finance.

16/ The circularity also begins to resemble China’s system in another way. In China, banks fund projects that sustain struggling firms; In the U.S., private credit funds refinance companies that sustain valuations and fund economics across the private-equity chain.

17/ The only difference lies in the funding source. Chinese repression draws on household deposits trapped in the banking system, while Western private credit draws on pooled institutional capital attracted by promises of stable, high returns.

18/ If that system unwinds, it doesn’t mean American growth was entirely illusory. But it likely means some portion of measured growth reflected subsidized expansion and capital recycling rather than durable productivity gains. On that front, since a relatively good wedge of the American economy is still propped up by actually viable dividend-producing companies, the U.S. is probably better positioned to deal with its involution crisis than China.

19/ Nonetheless, it still suggests the celebrated strength of deep Western capital markets may have a shadow side: instead of state-directed investment like China, the West has engineered planning by proxy — liquidity-driven capital allocation guided by incentives, narratives, and growth metrics rather than sustainable profitability.

20/ In that sense the private credit shake-out isn’t purely a crisis. It’s the painful but necessary process of defunding zombies and redirecting capital toward sectors where genuine productivity and durable returns exist.

21/ Don't get me wrong. The last decade’s repression-like conditions did produce real breakthroughs (just as the cold war space race did) — AI and other frontier technologies benefited enormously from that capital surge. But once the key infrastructure and platforms emerge, the system eventually has to transition from subsidized scale to productive investment.

22/ One final difference from 2008: unlike the GFC, the risk in the West also sits largely outside the core banking system and payments infrastructure. That means losses are more likely to show up as weaker investor returns and slower growth than as a systemic financial collapse. That's not the case in China.

23/ I should add that the above analysis applies more to the growth-driven tech / software / SaaS phase of the private-credit story than the conventional one.

But that doesn’t mean the earlier form wasn’t also susceptible to involution. The private-equity model by definition works by layering additional financial claims over largely unchanged cash flows through leverage and concentrated ownership.

Taking companies private replaces market-based scrutiny with sponsor-based scrutiny — the premise being that a smaller group of professional investors can restructure and grow a business more effectively than dispersed public shareholders.

In practice, however, much of the return comes from concentrating control and increasing leverage, which allows those investors to capture a larger share of the same underlying cash flows. Incentives are not always aligned.