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China's Debt-Fuelled Growth Rate

China is not interested in bailing Europe out. It has its own debt problem...

DO NOT for one second that China's growth is not a sham, writes Greg Canavan for the Daily Reckoning Australia.

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 it is 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 funneled 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 favor 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 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.

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 specializing 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.

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Greg Canavan is editor and publisher of Sound Money, Sound Investments, a weekly financial report devoted to unearthing great value investments amid today's "money illusion" of fiat currency. Formerly editor of Australia's market-leading finance newsletter, Greg has been a regular guest on CNBC, ABC and BoardRoomRadio, as well as a contributor to publications as diverse as LewRockwell.com and the Sydney Morning Herald.

See the full archive of Greg Canavan.

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