China: Tons of money, wanton waste

By Jim Jubak

China is awash with capital. But a sizable hunk of it is going into vanity projects, real estate speculation and unprofitable expansions of capacity in already unprofitable industries. Is China wasting so much capital that it puts the country's future at risk?

This is the third column in my series that asks just how sustainable China's economic boom is for the long term. The first was "Time running out on China's boom," followed by "How long can China pollute for free?"

How much capital does China have to invest in building its future?

The government's foreign-exchange reserve -- the result of the country's huge trade surplus with the rest of the world -- stands at more than $1 trillion. Direct investment in China from other nations came to $111 billion in 2006. The country's famously high individual savings rate, estimated at about 16% of gross domestic product by the World Bank in 2006, has stocked banks with $4 trillion in deposits. Chinese corporations are actually saving even more than individuals, about 22% of GDP, according to the World Bank. The Chinese government actually shows a surplus, kicking in savings equal to 6% of GDP to the national pot of capital.

But China doesn't always spend that capital wisely. In recent years, stories of vast amounts of capital poured into wasteful vanity or speculative projects have grown increasingly common.

For example, the government in Beijing ousted Shanghai Mayor Chen Liangyu last year, charging that city money was being used to fund "private" construction projects, such as using city pension money to build a 60-story Marriott hotel with a Ferrari dealership on the ground floor and a Shanghai version of Silicon Valley that combines high-tech office space with luxury apartments. Chen authorized plans for a branch of France's Pompidou Centre art museum and the world's tallest Ferris wheel. The city actually built a $300 million tennis arena and a $1 billion track for Formula One auto races.

This kind of waste of capital isn't recent -- the mayor of Beijing was dismissed in 1981 for the same lavish city spending that doomed Chen -- and it's countrywide. By 2005, China's central government had spent more than $250 billion to fix the bad-debt problems at the big four national banks created when bank officials approved loans based on political connections rather than creditworthiness. There's an additional $164 billion in bad debts outstanding, the government estimated in 2006. Credit rating agency Fitch, however, puts total troubled loans at $700 billion, which could result in $220 billion in bad loan losses.

The waste of capital is built into the Chinese economic system. Local officials control the flow of public and private capital, and they know, regardless of what Beijing may say, that the government rewards officials who produce growth and jobs no matter what the methods.

Shanghai during Chen's years in power was a national success story. No one wanted to call an end to a speculative game that produced huge numbers of jobs and big profits that could be spread high and low through the great interlocking complex of private entrepreneurs, local government officials and Communist Party leaders. There's really no chance -- short of a radical reform of the system that breaks the Communist Party's control of the economy -- that the waste of capital on a massive scale will end.

A tradition of waste

Still, just because the waste of capital is systemic and not likely to end anytime soon, it doesn't mean it's enough to endanger China's future. History is full of examples of countries that wasted and squandered their way to economic prosperity.

The United States, for example, took British investors for wild speculative rides, first in canals, and then, even though the bankruptcy of so many canal companies should have taught overseas investors a lesson, in railroads. The great robber barons Jay Gould and Cornelius Vanderbilt built fortunes by watering railroad stock -- impoverishing other investors who wound up with worthless shares -- and staging vast raids designed to corner one commodity or another in the financial markets of post-Civil War America. In the process, they gutted going concerns and destroyed millions in capital belonging to competitors.

They probably would have felt right at home with the current generation of politically connected Chinese speculators. Gould and his partner, James Fisk, paid off Boss Tweed, head of the Tammany Hall machine that ruled New York City, in their efforts to gain control of the Erie Railroad. The pair used President Ulysses S. Grant's brother-in-law in an attempt to influence Grant and his secretary of the Treasury during an effort to corner the gold market in 1869. That ended in the Black Friday panic that saw the price of gold drop by almost 20% -- after the speculators had driven it up 30%. Thousands of investors were ruined.

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