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Where Did the Money Go?

Australia's natural resources boom leaves it with A$200bn in new debt...
UP, UP and away! Markets got off to a flier this week, writes Dan Denning in his Daily Reckoning Australia.
The Japanese public has endorsed the idea of money printing. And the Chinese money printers have endorsed the idea of cheaper money. Naturally, Australian stocks are reveling in the idea that wallets may loosen in Asia and that bank lending for more make-work projects could increase.
If it were that easy to keep a boom going, then we'd have nothing to write about in today's Daily Reckoning. But you can't quite take anything at face value these days, especially money in the age of inflation. The task of today's note is to sort the good from the bad, and look the ugly straight in the eye.
The good, at least on the surface, is that the People's Bank of China (PBOC) has 'liberalised' interest rates. Specifically, China's central bank will now allow lenders to make loans below the benchmark lending rate of 6%. This financial market is designed to promote competition in the Chinese banking market and lead to more loans.
That all sounds fine. But data show China's banks were not lending near the previous 'floor' sets by the PBOC. In other words, Chinese banks are in no particular hurry to lend at lower rates and watch their net interest margin collapse. The net interest margin is the difference between what banks pay depositors and what they charge for loans.
In fact, there is quite a bit of debate over whether loosening lending requirements is even good for the Chinese banks. It might require them to hold more capital against riskier loans, which might require them to raise more capital in the equity markets. But doth we protest too much?
That is, isn't a good thing China's slowly opening up its financial markets to free market forces? 
Well, it would be a good thing if it were true. But we'll believe it when we see it. Mind you, there are no free markets in money any more. China is not alone in creating an unbalanced banking system backed by unsound money. But it's done as good a job as anyone.
The latest example is the construction of a 'mini-Manhattan' on the outskirts of China's northern city of Tianjin. Over 43 high-rise projects are planned in the Binhai New Area Central Business District, according to Angus Grigg in this weekend's Australian Financial Review. Three 100 storey towers are planned, including a Binhai version of New York's Rockefeller Centre. The grand plan is for 10 million square metres of office space, or double the amount in Sydney's CBD.
Before we go rubbishing the project as another example of local government loans financing unproductive real estate development – and showing how this blows bubbles in commodity markets which eventually put Australian investors at risk – we should point out that China is not Australia. That might seem obvious. But allow us to explain why it might matter.
China's great leap forward from poverty to middle class wealth has been engineered by the Communist Party of China. It's no small feat. Urbanisation and industrialisation, along with globalisation, have transformed China in the last 30 years. The creation of so much apparently excess office space capacity is the extension of China's development plan. And it's worked so far, hasn't it?
Well, to a point. But we're now at that point. From here, real economic gains in China will not come from starting from a low base (in terms of urbanisation, GDP, and industrial capacity). You can build office towers no one is going to use. But there IS an economic cost. That cost is in the misallocated savings of the banking system. And as our colleague Greg Canavan pointed out to us this morning, an emerging middle class whose savings are tied up in non-performing property developments is not a middle class that can consume more and lead China's much-vaunted-but-not-at-all-visible rebalancing.
Still, we know from past experience that these special economic zones are a way for China to direct foreign investment into new projects that create jobs and more capacity. What's more, the major cities compete with each other for this foreign direct investment. If you're an international company, investing in China is a political as it is financial, when it comes to balancing the competing cities.
What's really at stake here is whether Australian investors can take the investment bubble in China at face value, or whether it will be the catalyst for a major fall in the stock market. If that happens, it will be related to a serious crisis in China's financial system. And that raises an even more interesting question of whether you can have a real banking crisis in a command economy where the State owns the banks.
We won't take that question up in today's Daily Reckoning. However we would like to point out that the Australian Office of Financial Management (AOFM) will auction off $2.7 billion worth of debt this week. That's debt your children will have to repay someday.
The AOFM reckons there will be A$27 billion in net new debt issuance in 2013-2014. The actual total debt issued is around $50 billion. But $23 billion represents maturing securities. All up, there is now $258 billion in Commonwealth debt outstanding, in various notes and bonds.
How on earth can you come to the end of a resources boom having racked up over $200 billion in debt? That's a very good question.

Best-selling author of The Bull Hunter (Wiley & Sons) and formerly analyzing equities and publishing investment ideas from Baltimore, Paris, London and then Melbourne, Dan Denning is now co-author of The Bill Bonner Letter from Bonner & Partners.

See our full archive of Dan Denning articles

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

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