Don't doubt for a moment that China's growth is not a sham. When a country produces economic growth via the actions of self-interested individuals producing goods and services with a profit motive, the growth achieved is usually sustainable. (Provided its not financed entirely by debt)
When a country like China directs investments for the sake of employment and social cohesion, with no regard for the profit motive, the economic growth produced is unsustainable. It is just money being funnelled into a black hole.
Granted, this sort of stuff can go on for years and make naysayers like us sound like idiots. If you're long commodities, you probably think we are an idiot. But do yourself a favour and look through the history books. If you can find any centrally planned economy that prospered due to its leaders' wisdom and disdain for free markets, drop us a line.
Now even BHP Billiton is getting a tad concerned. At yesterday's AGM, the board indicated the mess in Europe is beginning to have an effect on Chinese customers. That sounded like a convenient excuse to us.
China's Growth Slows
China's steel producers are likely to be more worried about a tightening of the money taps in China than issues in Italy. China's construction of railway lines and bridges to nowhere is slowing because, surprise surprise, the departments overseeing the work are running out of money.
Earlier this week the Shanghai municipal government issued bonds for the first time in 20 years or so. The central government wants local governments to raise money transparently - instead of through off-balance-sheet arrangements as they have been doing.
The bonds were issued at rates of 3.1 per cent and 3.3 per cent - the same as borrowing rates for the central government. It was interpreted as a success. But given China's Ministry of Finance pays the interest on these bonds (the local government obviously can't afford to) it's little wonder they trade the same as China's central government debt.
China's Debt Grows
The point we want to make is this: China's government debt load is much bigger than most people think. According to the IMF, at the end of 2010 China's government debt was 34 per cent of GDP. But that doesn't include all the local government debt that the central government implicitly backs.
It's the local governments that have driven the credit boom. Using land as collateral to borrow to fund infrastructure projects, they have amassed hundreds of billions in debt. And because the projects they built are uneconomic, the local governments can only pay interest by raising more debt. It's a classic ponzi scheme.
So China's central government is on the hook for all these debts. According to Dragonomics, an independent research firm specialising in China's economy, the government debt to GDP ratio is closer to 90 per cent.
Even that is just a guess. The credit boom resulted in the establishment of thousands of finance companies as cover for local governments to go deeper into debt. Who knows what the actual amount of liabilities are? As the credit tide slowly goes out, we'll get a much better idea.
Perhaps that's why China has shown little interest in bailing Europe out. It knows it has plenty of problems in its own backyard.
As does Spain, Italy, France and just about everyone else in Europe except Germany. Europe's crisis is heating up - again. After a few days of delusion about the ability of 'technocratic' (puppet) governments to soothe worried bond markets, the battle is back on.
On one side you have a bunch of economic illiterates trying to make something work that clearly can't. On the other side you have the 'market' - the collective wisdom of people trying to protect their wealth - telling these fools their game is up.
It doesn't matter what your prejudices or preferences are, the Eurozone as we know it is breaking apart. The break-up can be managed and contained as much as possible, or it can be a complete disaster. Right now, the 'managed and contained' outcome is not looking good. The only thing keeping markets from all out panic is a belief that the European Central Bank will hand out free money and make everything alright. Talk about clutching at straws!
If you haven't had a chance to check out Slipstream Trader Murray Dawes' latest market update on YouTube, take 10 minutes to watch it right now. He's already predicted today's sell off. As one reader said, he's 'scarily accurate'. Click here to find out where the market's heading next.
Have a great weekend!
Greg Canavan,
for The Daily Reckoning Australia
P.S. to get The Daily Reckoning direct to your inbox sign up to our free e-mail newsletter or if you prefer to use RSS, subscribe to the Daily Reckoning RSS feed.
Related Articles:
- The Bigger Debt Problem: China’s Local Government Debt vs. US Subprime Debt
- Debt Beats the Economy in a Growth Race
- Invest in China’s Geeks and Guts
- The Cinderella Story of China’s Economy
- European Governments of the Eurozone are Separately Responsible for Their Euro-debt
About the Author
Greg Canavan is the editor of Sound Money, Sound Investments, a financial report devoted to unearthing great value investments amid today's "money illusion" of fiat currency. For a free trial of Greg's service, go to Sound Money, Sound Investments.
Comment by Chris on 18 November 2011:
Greg, you make some good points as usual.
I would like to add that an economy that generally does not allow free markets to operate, like China's, cannot continue its current growth rates for a number of reasons including running out of money.
A country that interferes in free markets creates so many imbalances that lead to problems with rising prices and income inequality which can also end the party, e.g. USSR. As you've mentioned resources are being allocated to unprofitable areas. That is even if the country has money these factors can make it ineffective as we have seen in the last 6 to 12 months where China can’t put its foot on the accelerator as much as it would like because at the same time it needs to slow the economy down a bit.
Comment by Tim on 18 November 2011:
"If you can find any centrally planned economy that prospered due to its leaders' wisdom and disdain for free markets, drop us a line."
Singapore, a country much admired by the Chinese leadership as a model they would like to emulate. ie 1 Party state, mostly market economy with the Govt (via Temasek & GIC) being controlling shareholder in most major companies.
Comment by Ned S on 19 November 2011:
"If you can find any centrally planned economy that prospered due to its leaders' wisdom and disdain for free markets, drop us a line."
China itself for 30 years - Including through the 1998 Asian Financial Crisis. (With the US not yet having the same track record behind them through their 2008 crisis; Or Europe through its current crisis.)
Comment by Michael on 21 November 2011:
So the US, Europe, Japan etc carries a lot of debt, and now China. That does not leave many large economies in the world not in debt.
The way I understand it is, there's borrowers, so there must be lenders. So if most of the major economies are in borrowers, so who are the lenders? Can someone please explain.
Comment by Patrick Donnelly on 25 November 2011:
China is immense. It still has 200Mn peasants willing to work for very little and more already working. It cannot fail.... but it can correct and pay less for rawms.
The biggest winner sector in a depression is infrastructure, but China has already perhaps over invested there. Not easy to predict since they lie in their stats!
In ten or twenty years, then it will have massive political problems. That is why the USA is using Darwin now. China is an empire run by a few million. Not even 1%! They will leave with their cash/gold/paper invested in Australia et al.
Comment by Jing on 21 February 2012:
1. Who owns China's debts. Its own people. 2. China's assets is exceeds to their liabilities and equities.