The other solution to Beijing's deepening debt problems
China has a government debt problem. Granted, it's not a problem on the scale of Greece, where public debt now stands at 165 per cent of gross domestic product. Nonetheless, China's debt burden is substantial - and worrying.
You won't get that impression from looking at the official figures. According to Beijing's numbers, at the end of last year the central government's debt stood at a mere 16.3 per cent of GDP - less than a tenth of the Greek level.
But that figure is misleading. To get a more accurate picture, you have to start adding in other state debts.
There is the 2 trillion yuan (HK$2.46 trillion) of debt run up by the Ministry of Railways to finance the construction of its high-speed rail network. That's another 4.5 per cent of GDP.
There are the debts of China Development Bank and Beijing's other policy banks, which come to at least another 10 per cent of GDP.
And there are the domestic debts that the central bank accumulated to finance the acquisition of its foreign reserves. Unfortunately, because of the yuan's appreciation, those debts now outweigh its foreign assets, leaving the central bank technically insolvent.
Add that lot together and you get a central government debt to GDP ratio of about 40 per cent.
On top of that, you need to factor in all the debts run up by China's local governments and their associated financing vehicles, which are estimated at anywhere between 15 and 20 trillion yuan. That's another 32 to 42 per cent of GDP.
And then there are the bad debts warehoused in the state asset management companies, the legacy of China's late 1990s investment boom, which come to around 7.5 per cent of GDP.
In total, that gives a public debt to GDP ratio for China of around 90 per cent. That's roughly the same level as Portugal, and considerably more than either the United States or Britain, where high government debt levels are widely perceived as a pressing threat to their economic future. Yet few people seem particularly concerned by China's public debt.
That's because, in the past, China has always been able to grow its way out of debt without difficulty. Running up debt of 90 per cent of GDP is not a great problem if those debts finance productive investments that propel rapid economic growth. After all, if you are growing at 10 per cent a year with low inflation, as China has over the past decade, the real size of your economy doubles in just seven years. That means your stock of debt halves relative to GDP over the same time period - end of problem.
At least that's how it has worked in the past. The fear now, however, is that the build-up of debt in recent years has financed the mis-allocation of capital on a gargantuan scale, and that the returns on China's capital investments are falling. That will make growth much harder to come by in future.
In other words, there is a danger China may not be able to grow its way out of its debt problem this time around. This, in a nutshell, is the argument of the China bears, who forecast a flood of debts turning bad and a colossal financial crisis as a result.
But there is another option. If Beijing can no longer grow its way out of debt, and assuming the government doesn't want an outright banking collapse on its hands, then Beijing can take the path traditionally followed by other governments around the world and inflate its way out of the problem.
Inflation is great for indebted governments and companies. As prices go up, the real value of their debts shrink. So if you're in debt and you can't generate real growth, you ramp up your nominal GDP by pumping up inflation, and your debt level still shrinks relative to your GDP in nominal terms.
Naturally, there is a price to pay. While inflation is good news for debtors, it is a disaster for anyone holding cash. And in China it is ordinary households who own cash, with 36 trillion yuan in household savings deposits at the end of last year, worth 77 per cent of GDP.
Rising prices would quickly whittle away the real value of those savings. So in effect, inflation would represent an enormous transfer of wealth from China's households to the indebted state sector. Once again, the people would pay for the government's misguided policies.
Hopefully, it will never happen. Policy-makers are well aware that inflation, once unleashed, is difficult to contain.
But if faced with declining real growth and the possibility of a banking collapse, there is a chance that solving the problem through inflation may yet prove too much of a temptation for Beijing to resist.