Hot Money In, Smart Money Out

China raised interest rates 25 basis points last night. Like tilting a giant bathtub, hot money will naturally roll in. But the smart money has been trying to get out of China.

Outlook 2011 and the Next Decade: China: Is the Smart Money Right

The country has major infrastructure issues, troubling population dynamics, poorly aligned employment outcomes, inflation problems, a real estate bubble, an opaque and potentially insolvent banking system (had mark-to-market accounting been applied), geo-political problems with North Korea and Taiwan, and an underperforming stock market in 2010 (see stock comparison chart).

So, multiply the bad business project factor by ten and you get an understanding of the magnitude of bad loans on the books of Chinese banks. The problem is being further exacerbated by the practice similar to Spain`s of banks making additional loans to the businesses just so that they can then turnaround and pay back the interest owed on the original loans.

Victor Shih, a Northwestern University professor estimates that Chinese local governments borrowed some 11.4 trillion renminbi at the end of 2009, and that local government financing loans to be roughly one-third of China's 2009 GDP. . . .