The Bigger #Debt Problem: China’s Local Government Debt vs. US Subprime Debt

Bill Bonner

"We're not bearish enough [on China]." - Jim Chanos

Oh my... China is breaking down. Europe is slipping. And there goes the US too...with stocks down 172 points on the Dow on Friday, closing out a 6th straight week of losses.

Even if the US holds itself together, there's a good chance that either Europe or China will drag it down.

The latest reports show China's property bubble beginning to lose air. The Wall Street Journal reports:

After years of housing prices gone wild, China's property bubble is starting to deflate.

Residential prices are heading downward in some major cities, damping some undesired real-estate speculation but raising the prospect that the Chinese economy may slow more rapidly than anticipated with profound consequences for global growth.

Real estate is a foundation of China's phenomenal growth record in the past two decades, and its health is crucial to China's construction, steel and cement sectors. Real estate is also a favored investment of Chinese looking to get better returns than bank deposits pay.

And legendary short seller, Jim Chanos, says China's local government debt is worse than America's subprime problem. Subprime debt in the US never surpassed 10% of GDP. China's local governments have debt (much of it bad) of more than 30% of GDP.

We went to China recently. We were unable to form a clear opinion about it. Yes, there were plenty of buildings that looked empty...but the streets were full of people.

And there is so much money in China! A friend is an antique dealer in Paris. He tells us that the hottest segment of the market is Chinese antiquities. As soon as something comes on the market, a buyer from China snaps it up. Here's an example. In March, an antique China vase was auctioned off at Sotheby's. The auction firm had appraised it at $800 to $1,200. Instead, it sold for $18 million.

With that kind of cash available, why worry about empty apartments? Surely, the demand will meet up with the supply, right?

Trouble is, without the discipline of the free marketplace, you never know what the demand really is. And given a lot of extra cash and credit from the feds, supply tends to overshoot, often spectacularly.

Without the light of real, free markets, buyers and sellers wander around in the dark like blind drunks. They stumble into each other. They fall down. They bloody their noses and make an awful mess.

In the heady air of post-commie central planning, China may have less than 10% of the world's GDP, but it buys more than half its cement - and nearly as much of its iron ore, steel and coal.

What does it do with all that? It adds supply! It builds.

From first hand observation we weren't able to draw much of a conclusion. But theory tells us that there is no way you can invest that kind of money - often with the help of local governments - without making some major mistakes.

Of course, that's why there are corrections. That's why every boom caused by excess, artificial credit is followed by a bust of excess, un-payable debt. Which is also why, here at The Daily Reckoning, we like corrections. They are like soap and water. They help get rid of accumulated debt dirt. And the grease of bad guesses. And the parasites that accompany a plan-gone-bad. So, lather up. Rinse well. And you're fresh and ready to go again.

But the authorities don't like washing up. After all, one man's grease is another man's career path. And the parasites vote.

The Chinese authorities may or may not be smarter than their American counterparts. But they've got parasites to look out for too. Voters? Maybe not...but they've got plenty of officials...and some 100 million young men looking for work; they're desperate to keep them busy.

We don't know whether a Chinese blow up is around the corner or not. But it could happen any minute.

(One of the Chinese stocks in our Family Office portfolio is trading at only 2 times earnings. It was more when we recommended it. And if China blows up, it will go lower still. Perhaps they will give it away at the bottom.)

And more thoughts...

Meanwhile, Europe grows more troubled and more troubling. The Greeks want money. The Germans want austerity. The European Central Bank wants another bailout. Germany's finance minister says he'll support more money for the Greeks only if lenders agree to take a haircut first.

In the streets of Athens, demonstrations have become everyday occurrences. And the government, desperate to raise money, is said to be putting price tags on the Parthenon, the Acropolis, and several islands. "Discount!" "Going out of business!" "Inventory Reduction Sale!"

It is not our place to give advice, but we will give it anyway. It is the same advice we give to underwater homeowners.

It is obvious that Greece cannot work its way through this problem. It would have to increase GDP by 12% a year for three decades in order to "grow its way out of debt."

Since it cannot pay its debt honestly, it should at least default forthrightly. Stop sniveling and complaining. Own up to having erred.

Don't borrow more money, in other words; renege...walk away... Be of good cheer, knowing that lenders will suffer the losses they deserve.

Default and be happy.

*** America is so rich...and so wasteful...that it could probably cut its spending by half and most people would still be fat and sassy.

Here's a report from The Daily Mail in London:

The US is providing hundreds of millions of dollars of foreign aid to some of the world's richest countries - while at the same time borrowing billions back, according to report seen by Congress.

The Congressional Research Service released the report last month which shows that in 2010 the US handed out a total of $1.4bn to 16 foreign countries that held at least $10bn in Treasury securities.

Four countries in the world's top 10 richest received foreign aid last year with China receiving $27.2m, India $126.6m, Brazil $25m, and Russia $71.5m.

Mexico also received $316.7m and Egypt $255.7m.

And yet despite the massive outgoings in foreign aid, the receiving countries hold trillions of dollars in US Treasury bonds.

China is the largest holder with $1.1trillion as of March, according to the Treasury Department.

Brazil held $193.5bn, Russia $127.8bn, India $39.8bn, Mexico $28.1bn and Egypt had $15.3bn.

*** And here's another little item. As we keep saying, man is neither good nor bad, but subject to influence. And what's the real effect of modern communications technology? A report from Miller McCune.com:

From reality television to dumb-and-dumber films, contemporary entertainment often amounts to watching stupid people do stupid things. New research suggests such seemingly innocuous diversions should have their own rating: LYI.

As in: Watching this may Lower Your Intelligence.

A study from Austria published in the journal Media Psychology found students performed less well on a general-knowledge test if they had just read a short screenplay about an idiotic thug. This suggests stupidity may indeed be contagious - particularly if it is presented in narrative form.

"Narratives tend to make people 'walk in someone else's shoes,'" Appel notes. Since that experience can be temporarily transformative, you might want to make sure the characters you follow have IQs higher than their shoe size.

Regards,

Bill Bonner,
for The Daily Reckoning