China's Economic Cracks Are Getting Bigger

by: Carlos X. Alexandre

Although China has been on the news mostly as an appendage to Europe, there’s plenty to cover about the Chinese economy itself, and MarketWatch reported that “analysts are struggling to keep track of recent moves to put a lid on China’s escalating debt troubles, as worries swing from non-performing loans to an out-of-control shadow-banking sector.”

While China’s listed state-owned banks were generally given a clean bill of health in recent results, a steady trickle of unsettling news has hit confidence and heightened fears that the recent lending spree will end in an ugly unraveling.

A large part of the debt problem is that the money was spent on useless projects, and even though jobs were created, the end product is not being used. For example, how is transportation-related construction characterized by National Planning Expert Committee member Lu Dadao, according to Caixin? "Excessive."

First, look at expressway construction. In 2008, the nationwide total mileage plan was adjusted up to 100,000 kilometers. That year alone we built 6,433 kilometers and invested a total 600 billion yuan. Nationwide expressway mileage is expected to grow to a staggering 180,000 kilometers, if we add provincial and national building plans. Personal vehicle traffic levels are too low on some expressways built over the past five years. Considerable stretches of expressways completed in central and western regions are usually empty, simply basking in the sun. Thus, expressway construction has suffered from excessive expansion. It's gotten out of control.

What I am sensing is an increased openness and candidness that was absent a few years back, and Wu Jinglian, an economist at the State Council, added his observations. From Caixin:

Wu said the biggest challenge facing China's market reforms is the government's dominance in economic activities, arguing that it continues to distort market competition.

Without a doubt, China’s foreign exchange reserves are always used in crafting positive arguments about the country, but the bills keep pilling up. From MarketWatch on November 3rd:

China's Ministry of Railways owes 249 billion yuan ($39.2 billion) to three-dozen publicly listed construction companies helping build the nation's high-speed rail network, according to mainland news reports Thursday which cited figures by mainland data compiler Wind.

Thus financing creativity is starting to take a bite out the central planner’s control, considering that “Chinese law prohibits local governments from issuing bonds directly,” as reported by MarketWatch.

China’s cabinet has approved a trial plan that will enable four local governments to issue their own bonds, enabling access to debt markets that could help alleviate financial stress, according to reports from the region on Thursday.

The Financial Times published an article that highlighted the core issue in China: Government control.

Despite this radical transformation from a communist to a seemingly ultra-capitalist system, the party keeps calling it socialism, and for one reason: Its monopoly on power must not be challenged.

In response to the increasing dissatisfaction that propagates through social media, the government still resorts to beautifully crafted propaganda to infuse its citizens with a sense of responsibility for the greater good.

This lack of confidence and firm beliefs, and citizens’ willingness to speak out about their confusion, is what worries the party. “In some areas there is moral decay and a lack of trust, some citizens’ outlook on life and values are distorted, there is a more urgent need to lead society’s thinking with the core socialist value system,” the central committee said in the resolution it published last week. “(We must) raise our public opinion guidance skills and urgently need to strengthen and improve our .. controls of the Internet.”

Meanwhile, and as lower inflation is celebrated, the conditions for businesses and citizens continue to deteriorate, as reported by Bloomberg’s article “China Credit Squeeze Prompts Suicides.”

Wenzhou’s 400,000 businesses are facing financial hardship because of rising costs, soaring black market interest rates and a sudden credit squeeze, Zhou said. Similar problems are happening across China because private enterprises in China rely on underground borrowing rather than banks to operate, he said.

And considering China’s domestic economic problems, the population is increasingly becoming more vocal regarding a variety of issues, and we know that freedom of expression is not highly regarded. Reuters’ article, “Analysis: Beijing risks public backlash if it rescues Europe,” sheds light on the issue.

Ahead of a G20 summit in France on Thursday, tens of thousands of ordinary Chinese have been venting their anger online, demanding their leaders sort out China's own problems before bailing out Europe. "Domestic pressure (on China's leaders) is huge. Ordinary people are condemning" any decision to throw Europe a lifeline, one source with ties to China's top leaders told Reuters, requesting anonymity because of political sensitivities.

At this stage and from a political standpoint, the voices of the people are far more important than the needs of the global community.

It’s easy to still elevate China from a macro perspective, especially when one looks at "official" economic data without a critical eye, and chooses to ignore the fact that China is not self sustainable. But when individual accounts and reports are weaved together, reality trumps the perceptions of an invincible economic system that still abounds, and the fallout of failed policies will take its toll domestically and globally. But just like all other politicians on Earth, the Chinese government will keep the charade alive for as long as possible.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.