^{Originally published by QFINANCE}

By political commentator Ian Fraser

Last year very few commentators saw a doomsday scanario developing for the Middle Kingdom. These few included some lonely hedge fund managers such as Eclectica's Hugh Hendry and Kynikos's Jim Chanos. The country’s property bubble, troublesome banking sector and credit tide caused the most concern.

The China-bashers were given a pause for thought when second quarter data showed that China's economy grew at 9.5% in the second quarter -- meaning its economic engine has shown unexpected consistency over the past 12 months. However, wrapped up in the figures were warning signs, including that consumer price inflation reached 6.4% for the year to June. And, as The Economist pointed out, despite a state-sponsored slowdown on bank lending, overall credit availability has actually increased thanks to increased use of "social financing", including corporate bonds and some loans repackaged by “trust” companies. The Economist said:

"China seems to be getting less bang for its financial buck. In 2007, Fitch reckons, it took 1.28 yuan of extra financing to produce an additional yuan of GDP. Now it takes 2.38. China’s growth may be remarkably even. But its financial system is having to pump harder to maintain the pace."

It's fair to say scepticisim about China, its post-crisis success and the nature of its economic miracle has been growing in recent weeks.

On July 5 the credit rating agency Moody’s warned that China’s local governments have understated their indebtedness. Moody’s said local government debt may be 3.5 trillion renminbi ($540 billion) larger than state auditors have estimated, saying this exposes the country's banks to the risk of deeper-than-expected losses, which might jeopardize the banks' credit ratings. The rating agency said a jump in defaults by local governments could "push the nonperforming loan ratio for Chinese banks as high as 12%, well above its base-case scenario that envisions losses in the range of 5% to 8%," Reuters reported.

Michael Kurtz, Asia strategist for Macquarie Securities, weighed in with a scathing attack on China in the Wall Street Journal. He accused the Communist Party of China of hubristic gloating in its response to the global financial crisis and questioned whether the country's blend of political authoritarianism and economic interventionism could work long-term. Kurtz wrote:

"China's leaders appear more confident than ever that their ... policies are superior. This is not surprising since even in the worst months of the global financial crisis, Chinese growth held above 6%. Meanwhile, the Western market economies slumped into deep recession and are still struggling to regain their footing. Yet, a recent spate of tough economic and political challenges, several directly resulting from its crisis-period policies, calls into question Beijing's self-congratulatory narrative. What's worse, China's essential economic transformation in the decade ahead will succeed only with further relaxation of state interference in human affairs, meaning the authoritarians' renewed self-satisfaction may come at substantial future cost."

He cited occasions since the crisis when Chinese government sources have used the crisis as an ideological stick with which to beat the west - and hype the virtues of their brand of authoritarian socialism. But Kurtz said China's "triumphalism" may be premature, as:

"A slew of problems is emerging, from pernicious inflation to massive new bad debts to broad dissatisfaction over property market conditions to a surge in corporate governance and corruption concerns. These suggest not only that Beijing's command/control response to economic crisis was less successful than first trumpeted, but that faster liberalization may offer the only path by which China might avoid the slide to economic "also ran."

"Free markets are calling Beijing's bluff. The value of mainland stocks traded in Hong Kong (so-called H-shares) remains below their January 2010 level, left behind by an 18% recovery in the broader Asia ex-Japan regional index. The going has been even tougher for A-shares listed in Shanghai, down 11% over the same period. Last week, Singapore's sovereign asset manager Temasek, a group that understands China deeply, further roiled markets with the announcement that it is selling substantial shares in two Chinese state-owned megabanks."

Kurtz argued that the only reason for “China's much-ballyhooed crisis-period policy "success" was the massive surge in bank lending in the aftermath of the global crisis. He said policymakers had flooded the economy with credit totalling more than 30% of GDP in a matter of months, with a similar surge in 2010. But the dangerous aftermath has included higher inflation and a “powder keg" in the country’s property market. He concluded by writing:

“China has indeed achieved amazing things since its modern reform era began with Deng Xiaoping's ascension in 1978, not least including lifting the largest number of people from poverty in world history. But most of China's modern economic miracle came through reductions in direct state control and increases in economic and personal freedoms.”

Clearly there's no such thing as a perfect socio-economic model, but Kurtz probably has a point. Too much centralization, and too much state control invariably leads in the long term to economic sclerosis and higher levels of corruption (and even state-sponsored kleptocracy).

One amusing spin-off of the current mudslinging between the US and China is the recent spate of tit-for-tat downgrades and red flag from Dagong Global Credit Rating Co and Moody's Investor Services. On July 13, Moody's sounded the alarm over accounting and governance risks at dozens of small Chinese companies. This was despite upgrading the country as a whole on May 11.