Why No One Really Knows What is Going On With China's Economy

China watchers may be a bit disturbed by ghost shopping centers, apartment buildings, and entire ghost cities. They may even be slightly bothered by the large volume of bad loans made by banks to non-viable state owned enterprises. But what should really be bothering China watchers is everything else that is going on in the economy, that not even China's government can keep up with.

A two-week tour this month through Fuzhou, Shanghai, Beijing and Chengdu highlights the extent to which local banks and governments are devising new and clever ways to supply money to capital-starved businesses without going through official channels. These new sources of capital raise doubts about Beijing's control over the financial system, as well as its ability to reduce inflation and forestall a crash in the property market.

...This problem is twofold: It is very difficult to capture information about nonbank sources of lending, which comprise everything from corporate balance sheets to unrecognized promises for future profits. Second, the bank regulators control only the banks, but not the whole economy. They are in a tug of war both with China's planning board—the National Development and Reform Commission—and local governments, all of whom have a vested interest in spending as much money as possible.

Arguably, this shadow banking system has a positive side. It is teaching wealthy Chinese how to evaluate the costs and benefits of recycling their savings into profitable projects, instead of leaving them in low-yielding bank deposits that could be funneled into useless investments. One of my former interns said her father, a metals trader in Shanghai, constantly receives investment proposals for private projects and probably has a good sense of what is a good and bad investment.

But the downside is more frightening. There is a rampant growth of credit, uncontrolled or even incalculable by the country's top leadership. This means the financial system is generating liabilities that could easily turn sour and, come some kind of crisis, prove difficult to clean up. Does this remind anyone of America's subprime crisis? _WSJ

This means that the numbers that you are shown may have very little to do with the actual state of affairs in China. The underlying reality may be better, or it may be worse, than what you are being told.

There is plenty or room for surprises, so beware.