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“Democracy is a form of worship. It is the worship of jackals by jackasses.”

                                    H.L. Mencken

Commentary & Analysis

If China Saves Europe, then Who Saves China?

China’s real debt level appears to me much larger than anyone seems to know — even the Chinese. This kind of thing happens when you provide stimulus to your economy ranging from 50% to 75% of your entire GDP and allow your banking system to create even more leverage with a multitude of so called “off-balance-sheet vehicles.” Sound familiar to anyone? This movie ended badly during its first run.

But of course, it is only the Westerners who are careless with debt and leverage according to the harangues from Windbag Wen Jiabao, China’s globetrotting premiere who has learned the sublime art of Western political success: see camera, pose for camera, say sound bite to camera. Of course, Wen’s sound bites have about 500% more thought embedded in them than those emanating from Western pols, sadly.

Despite Wen’s recent attempt to tell the world, via op-ed in the Financial Times, “It is all good,” keen and un-keen observers alike have a sneaky suspicion Wen is playing one of his dutiful dual roles as Minister of Misinformation Information Dissemination—a highly valued practitioner of this art he has proven to be.

Commies have certain advantages in the disinformation role beside the fact it is part and parcel to their DNA. If said Commie can produce wealth, he is protected by friends like Henry Kissinger (yes I am reading his new book, Kissinger On China, and have not been disappointed) and a host of other international elites from both ends of the ideological spectrum reaping huge gains on Chinese real asset investment and had an added advantage in the art of deception. Think tanks in Western countries take up the cause and pretend that what we do with China represents “free trade,” and anyone that dare see the emperor is naked must be of the most horrible sort imaginable—an “isolationist.” The worst slur in Western economics indeed! But I digress, as real people with independent minds know this game all too well … as they watch jobs evaporate across every community.

From Wen in his Financial Times piece published on June 24th, “How China is winning the fight against inflation,” and my English skepticism translation in red:

“The world must cooperate to meet the challenges.” In other words, the West needs to keep its markets open and tariff free, while China continues to tax imports at 25-40% and require training of domestic partner (so technology can be transferred).

“China has moved swiftly to fight financial crisis, adjusting macroeconomic policy to expand domestic demand, and introducing a stimulus package to maintain growth, advance reform and improve people’s lives.” China has drained more savings from consumers, lowering the consumer penetration as a percentage of its total economy, thus making massive new investments and providing exporters all types of government incentives to push more final goods out on its trading partners, and cracking down hard on foreign competitors inside China instead of accepting the domestic adjustment and making real change to its consumer market. And just ask Chinese artist Ai Weiwei how that “reform and improving people’s lives” is turning out.

“There is concern as to whether China rein in inflation and sustain its rapid development. My response is an emphatic yes.” My response is an emphatic no that both can be achieved at the same time. Inflation can be reined in, but given the treadmill of required government stimulus to keep the vicious treadmill turning [see chart depiction below] growth will have to slow below the pace of its “recent development.” I read a quote from a hedge fund manager recently regarding this topic, he said, “China has two speeds, flame thrower and fire extinguisher.” They may now be applying the latter.

“Our budget deficits and debt balances are respectively below 3 and 20 percent of GDP.” Yeah…sure they are.

This from Radio Australia [my emphasis]: China’s local debt higher than expected…

For the first time in China, the debt levels of local governments have been published.

The National Audit Office says local government debts total 1-point-6-trillion dollars — or about a quarter of China’s national income or GDP.

It confirms for most analysts that the true extent of government debt is much higher than officially stated.

Correspondent: Karon Snowdon

Speakers: Stephen Joskie, director, Economist Intelligence Unit in Beijing; Shane Oliver, chief economist, AMP Capital

SNOWDON: Even with the official figures published no-one seems able to agree just how high the level of government debt goes in China. And therefore, if it’s a problem or not. Stephen Joske, is a Director with the Economist Intelligence Unit in Beijing.

JOSKE: It’s certainly a big number and it’s possible we’re only looking at estimates of its true size. It’s not clear it’s the absolute limit on it. There are some suggestions there might have been further items in there that we aren’t truly taken into account.

SHANE OLIVER (chief economist, AMP Capital): I think always there’s a possibility the Chinese government is fudging the numbers. Don’t forget China is still an emerging country so there’s a lack of precision in the numbers that might apply to Australia or the US. My take on it though is that in the greater scheme of things its likely to be relatively low.

SNOWDON: Shane Oliver is the Chief Economist with AMP Capital. It’s a constant problem with Chinese statistics — how accurate are they and just what’s been included in the calculation. Among the pessimists is Professor Victor Shih from Northwestern University in the US. He’s widely quoted as estimating local government debt is almost twice the official figure — that’s 2.6 trillion dollars or more than 40 per cent of GDP.

The consultancy, Dragonomics in Beijing agrees and says when adding central government debt the total is 80 per cent of GDP. Germany’s is put at 75 per cent and the US 93 per cent. Whatever the figure — does it matter?

Not yet, says Stephen Joske.

JOSKE: At the moment it’s probably fair to say that at 27 per cent of GDP it sounds like a big number but it’s manageble in the Chinese fiscal context. But it could easily be a lot more. But still we don’t have grave fears for it destabilising the economy largely because the overall fiscal situation in China is actually reasonably strong at the moment.

SNOWDON: In its favour, are China’s high economic growth, low interest rates and government ownership of assets. But inflation is rising — a big concern for Beijing. Just this week, Premier Wen Jiabao has shifted the inflation target from four to five per cent. But higher interest rates won’t necessarily follow — they might help to rationalise investment spending, but are politically sensitive.

JOSKE: The whole capital intensive state owned enterprise sector is built around access to fairly cheap loans, large sections of the real estate market are obviously based on interest rates around current levels. And if you start increasing those significantly you probably set off what by Chinese standards would be hard to manage political unrest.

SNOWDON: A lot of the Beijing’s massive stimulous spending went through local governments into infrastructure, some of it white elephant but much of it productive. A whole lot more was siphoned into real estate and through unknown financial vehicles. It could be a problem in the longer term for the banking system if those loans turn bad.

OLIVER: I think the odds are, there will be some problems for China’s local governments and as a result for the banking system as a result of the spending binge that occurred through the global financial crisis. It’s inevitable that some of the projects that were undertaken will run into difficulty and have trouble servicing their loans. That in turn could create problems for Chinese banks which have made the loans to local government funding vehicles. So there’s a likelihood we will see a pickup in problems in the years ahead.

The Chinese economy has been a juggernaut, no doubt. But it is dangerously imbalanced. This from Professor Michael Pettis:

One thing worth noting in the current environment is that small and medium enterprises (SMEs) are hurting, and last week’s minimum reserve hike – which came out the same day as the CPI number – will undoubtedly make things worse since any withdrawal of credit is unlikely to affect the top customers (SOEs and local governments) and will fall disproportionately on marginal borrowers. In early May I wrote that the very uneven process of rebalancing in China was likely to have adverse consequences on the SME sector.

Rebalancing in the context of China means, for the most part, a significant increase in the consumption share of GDP from its astonishingly low level of 35% in 2009 (and perhaps lower last year). As regular readers know, I do not believe that China’s high savings and low consumption rates are a function of any remarkable preference on the part of Chinese households for savings over consumption.

They are simply the automatic consequence of a system in which increases in GDP growth are subsidized by transfers from the household sector, which effectively constrains the relative growth of household income and, with it, household consumption. In that case the only way for China to rebalance would be for Chinese household income to grow faster than GDP.

There is nothing in the above comments from various analysts that Wen doesn’t know. But making the transition, or rebalancing, to a more level form of growth for China is extremely dangerous in a world where demand is still in hiding, and seems to be heading for a double-dip in the US, not to mention the rising social unrest evidenced by the rising number of riots (sorry, the proper term is “incidents” according to Wen’s Ministry of Disinformation Information Dissemination) throughout China.

US Consumer Credit Turning Down Again?….Private deleveraging isn’t good for Chinese exports. Thus, they need to rebalance toward more domestic demand sooner, rather than later.

It keeps coming back to the treadmill we created to depict this dangerous situation for China and the global economy…

If China slips off the Treadmill, the question is: who saves China? I have a feeling that if China is in need of liquidity, it won’t be holding European paper all that long.