What happens if China Goes

Everyone on this side of the pond except the most pessimistic (like Glenn Beck) have been pointing to the positive signs of an economic recovery. This is particularly true in the Obama Administration and the Democratic controlled Congress where nearly all of the future plans depend on the ability to pay for increased government spending through rising tax receipts, whether it is from the growth of a recovering economy or targeted tax increases.

To date, I think the global recession has not become a global depression because China has been one of the few economies that has not slipped into negative growth. The primary reason for this is that the government and the ruling Chinese Communist party cannot afford to allow the economy to dip below 8 percent annual growth. That's right folks. While the economies of the west have just slipped into negative territory, the Chinese are working feverishly to prevent their economy to fall below 8 percent growth. Even in good times, our Federal reserve tries to dampen the economy when growth reaches about three to 3 1/2 percent.

The Chinese have been trying to achieve this by opening the spigots on lending. This is not good. The Chinese are creating a lending bubble that rivals the housing bubble that was probably the single biggest reason for the collapse of our economy.

China's banks are veering out of control. The half-reformed economy of the People's Republic cannot absorb the $1,000bn (£600bn) blitz of new lending issued since December.

Money is leaking instead into Shanghai's stock casino, or being used to keep bankrupt builders on life support. It is doing very little to help lift the world economy out of slump.

According to the UK Telegraph:

"With much of the world immersed in crisis, China appears to be one of the few countries where the financial system continues to function largely without a glitch, but Fitch is growing increasingly wary," it said.

"Future losses on stimulus could turn out to be larger than expected, and it is unclear what share the central and/or local governments ultimately will be willing or able to bear."

This massive lending spree is being pushed by the government.

The regime is so hell-bent on meeting its growth target of 8pc that it has given banks an implicit guarantee...

Bank exposure to corporate debt has reached $4,200bn. It is rising at a 30pc rate, even as profits contract at a 35pc rate.

Fitch traces the 2009 bubble to the central bank's decision to cut interest on reserves to 0.72pc. Bankers responded to this "margin squeeze" by ramping up the volume of lending instead. Over half the new debt is short-term. Roll-over risk is rocketing. China's monetary stimulus since November is arguably more extreme than the post-Lehman printing of the US Federal Reserve, though less obvious to the untrained eye.

The Chinese economy continues to pump out goods for an export market that has not yet recovered.

China's Banking Regulatory Commission fired a warning shot last week. "The top priority at the moment is to stop explosive lending. Banks should carefully monitor the process of credit approval and allocation, and make sure that loans flow into the real economy," it said.

Unfortunately, 40pc of the "real economy" consists of exports, mostly to the US and Europe, the consequence of a mercantilist export model that has crashed and burned. Chinese exports were down 26pc in May.

And as happened in 2008 here in the US, commodity speculation is playing a big part in the banking bubble:

Andy Xie, a Sino-bear and commentator for Caijing, said Western analysts are in for a rude shock if they think that China's surging demand for raw materials implies genuine recovery.

Commodity speculators have been using cheap credit to play the arbitrage spread between futures and spot on the oil markets. They have even found ways to trade lumber to iron ore by sheer scale of leverage. "They've made everything open to speculation," he said.

And while western governments have avoided "protectionist" impulses to keep factories working, the Chinese are falling in to a trade trap.

...the regime is resorting to hazardous methods to keep excess factories humming: issuing a "Buy China" decree: using a plethora of export subsidies; holding down the price of coke, bauxite, zinc and other resources to lower production costs (prompting a complaint from America and Europe); and suppressing the yuan, again.

Protectionism is a risky game for a country that lives off global trade and runs a surplus near 10pc of GDP. Mr Pettis said he fears China is nearing its "Smoot-Hawley moment", repeating the US tariff blunder of 1930 that brought the world crashing down on Washington's head.

So while everyone on this side of the pond keeps looking for "green shoots", we might be dragged down by the collapse of an economy whose sheer size cannot be fought off by the combined might of the central banking system worldwide.