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If there’s one thing everybody knows about China’s economy – it’s that China has no national debt, right? After all the model of save everything you earn and pay no taxes is the best way to run a country that spends nothing. Except of course, China is spending money – lots of it.

If “everybody knows” such-and-such, then it ain’t so, by at least ten thousand to one. — Robert A. Heinlein

I'm not suggesting that you place all your faith in the sayings of science fiction writers, like Robert Heinlein. But sometimes they make a great deal of sense. And certainly more sense than most mainstream media reporters.

Here in Shenzhen, we have a brand new underground Metro system – it’s world class, and most “developed” nations would be jealous of just how fab it is. Then of course you have the high speed rail links that are popping up all over the country, the power stations and mining operations to keep them fuelled, and the new hospitals and universities, a road network… in fact all the things you’d expect to build in any country.

All of these things cost a lot of money, and rather more money than a nation (that is only really using land leases to generate provincial and major government income) is likely to have lying around in a tidy pile. So China, like everywhere else borrows money to pay for all these projects and that money comes from China’s banks – China’s debt is much less than most Western economies’ debt but it’s still a healthy 70% of GDP! So China’s savings aren’t going unused they’re being spent inside China’s economy.

So far so good –it’s the first acknowledged step along the road of internal economic development to spend money on infrastructure, and it creates more jobs and puts more savings in the bank to be used elsewhere. However, this is not always good – particularly if the folks investing your money aren’t entirely sure what to do with it.

China’s a big place (very big) and there are lots of people here – 1 in 5 of all the people in the world are here. And until 30 years ago, it wasn’t a very developed place at all – in fact there was very little education of any real import (reading, writing, ‘rithmetic and history lessons – at a basic level but not much more) and financial management and business planning courses were irrelevant because there was no money and all businesses worked for the country to earn a share of nothing. That’s pretty easy to achieve even if you’ve got no education.

In terms of day to day life - provincial governments have far more direct influence than central government. This only changes when dramatic national level decisions need making in a heartbeat.

Fast forward 30 years and you have the abiding myth, in the West, that central government runs every aspect of day to day life in China. It’s not true – it couldn’t possibly be true, there’s no doubt that China’s senior politicians are an amazingly clever and able bunch of people but managing 1.3 billion people by remote? No way, Jose. In practice what happens is that Beijing tries to direct and plan the high-level stuff and then provincial governments are left to execute the strategy and decide how to make that work on a local level.

This is where the problems start creeping in, Beijing’s policies are sensible – well thought out and in many areas they’re more advanced than our own government’s policies (particularly when it comes to the environment). But the local authorities don’t have the skills that Beijing does, and they’re all acting in the interest of their own provinces anyway – this leads to a lot of bad investment. Why? Because 12 parts of the country will simultaneously try and become a world leader in one area of technology (LED is a good example).

This leads to a sustained spend on building factories that make LED’s, and lending money to buy the equipment and hire a workforce (job creation is an enormous driver in all provincial spending – and if you remember China’s 300 million people in poverty, you’ll understand why) and so on. Without the slightest hope of all these factories making money, because the factories will be competing in an over saturated market and having to survive by selling at a loss.

LED is a good example because it's one I know something about - in Shenzhen alone there are nearly 2,000 LED factory businesses. And the local government has admitted it expects 1,950 of them to go broke this year. China's LED plants operate at the lowest level of LED technology and produce far more LED's than the market requires. The biggest successes so far in Chinese LED companies - are those that have persuaded local governments to buy back the product (yes, with those lovely loans from Chinese savers) and use them for demonstration purposes... you can see where the long-term issues with this solution are I'm sure.

This is a real problem (and there are many other reasons that provincial governments aren’t doing what they should with Chinese savings) and Moody’s (the international rating agency) was the first to sound the alarm bell on this. What happens exactly when it turns out that much of the debts incurred – cannot be paid back? It’s possible that most of that 70% of China’s GDP is gone – and isn’t coming back (though a more likely scenario says that 30-50% of the 70% is lost)!

The Chinese themselves think they are prepared for this (at an individual level) and this neatly brings us to our next topic to do with savings and where all the money is going – real estate. And that starts tomorrow.

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