James Leroy Wilson's blog

Wednesday, May 11, 2005

China: Miracle or Mirage?

Mirage. Definitely mirage. It's an economy based on government corruption and fraud. Karim Rahemtulla describes the operation:

Chinese banks, a.k.a the government, are saddled with hundreds of
billions of dollars in non-performing loans. That is, if you use their published
numbers, which are shaky at best. Yet, they continue to lend businesses whose
owners are making money, not from product they sell, but from how much they can
siphon out of the company knowing they are not being held accountable. As I see
it, it goes something like this: You get a loan that you don't have to pay back.
You produce goods that you then sell below market to generate cash flow. You
then show a loss from operations, since you spent more to make the product than
you are selling it for. You pocket some of the cash flow, since the debt service
is non-existent. You use your newfound profits to put deposits on new office
space and apartments that you are planning to flip - since in China you don't
have to pay for the space until it is completed, and by then if prices have
collapsed, you can just walk away. And since few Chinese pay taxes in this
"voluntary system," most of your "earnings" are also tax-free. So why does the
government put up with this?

There are two reasons that I can come up with. First, corruption in
the Chinese government is about as common as smog in Beijing. The skids are
being greased at every level. Capital is being provided for these companies via
share sales in the global markets to keep the party going after the loans run
out. Basically, this is how business is being done. Now, this may not be the
case for every Chinese company, but elements of this type of chicanery cannot be
isolated incidents or the number of bad loans would be much lower.

The second reason, and just as troubling, is that the government
cannot control the new capitalism that has been unleashed across the country.
People are seeking a better lot in life and finding it through commerce. With
1.3 billion people, it could be an ugly scene. So, the government is filling the
trough of liquidity, basically subsidizing the entire urban population, to avoid
an uprising. Money is flowing, goods are being sold, buildings are being built -
and all within an artificial cost structure.

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