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A Bear in the China Shop

It's an article of faith among China bulls that the nation's astonishing rise from economic backwater to global behemoth is a fait accomplit. Compound growth at 8 percent per year endlessly into the future, and in a few years' time, China's economy will be larger than that of the U.S. In another few decades, its per capita income will rival America's. Chinese officials describe their nation's evolution as a peaceful, carefully managed, linear process. And given how China has performed in the past two decades, it's not too hard to extrapolate recent results endlessly into the future.

Like most China bulls, I came away from a visit to the country (in late 2009) impressed by the infrastructure, energy and growth. But signs of stress and unsustainability left me with some troubling questions: How was it that every provincial leader knew exactly what his city's GDP would be for the upcoming year? And isn't the longstanding one-child policy setting China up for a demographic problem of epic proportions?

Part of my skepticism was informed by hours I spent in graduate school poring over books on American history. Lengthy rides are rarely without bumps or significant setbacks. America's glorious economic history -- a startling rise from colonial backwater to global hegemon in a few short centuries -- is filled with long periods of recession and depression. Parents of teens will note that adolescent growth spurts bring side effects: cracking voices, acne, clumsiness, growing pains, a sudden realization that parents are deeply uncool. The same holds for national economies. And in recent weeks, there are signs that zits are starting to pockmark China's complexion. A series of stories, data points and anecdotes suggest that the bulls who have dominated the China shop may have to cede some territory to bears.

Nothing personifies the alleged superiority of China's system more than its commitment to building an integrated, comprehensive high-speed train system. New York Times columnist Tom Friedman is constantly citing China's high-speed rail network as a sign of China's can-do spirit. When the train connecting Shanghai to its airport hit a speed of 250 miles per hour, I stood in the aisle and marveled at the engineering feat. I flash back to that moment most mornings when I board the Metro North commuter train, with its Eisenhower-era cars traveling at Eisenhower-era speeds. But in late April, the Washington Post reported that China's choo-choos are not all they're cracked up to be. Top officials have been fired, there's a corruption investigation, speeds have been cut due to concerns about safety, and the economics don't quite work out.

The Three Gorges Dam, which makes the Hoover Dam look like a beaver dam, is another stunning testament to Chinese engineering capabilities and the nation's ability to bend nature to its whim. In late May, the New York Times reported that China's government has conceded that it is "troubled by urgent pollution and geologic problems." Those include "floating archipelagoes of garbage, carpets of algae and landslides on the banks" in the reservoir created from the dam's construction. Then there's the matter of the 1.4 million people whose homes were inundated.

While the dam still stands, there are signs that China's vaunted central economic planning is falling down. Thanks to a policy of keeping energy prices low while encouraging ever more use, the Wall Street Journal reports today that China is thinking of raising power prices to help cut demand. "The China Electricity Council, a research arm of the central government, estimated earlier this month that power shortages at peak times this summer could be the most severe since 2004."

And if you think the U.S. has a troubled monetary policy, consider China's. The combination of a relatively inflexible exchange rate and a commodity-intensive economy leaves you particularly susceptible to inflation. Inflation in China is running at about five percent. In the coastal areas, a genuine wage-price spiral seems to be starting. Higher prices for real estate, food and services push companies to raise wages for restive workers, which boosts their ability to pay higher prices. But this dynamic also makes Chinese goods more expensive overseas. To high wages, add a currency that is slowly appreciating against the dollar, and rising energy and shipping costs. Pretty soon, China's value proposition as a low-cost production center starts to erode. I met last week with the CEO of a large U.S. consumer products company who is starting to in-source production of certain high value-added products from China to the U.S.

This is not to say that China will soon plunge into recession. But there are signs that it's current pace and style of growth is unsustainable. For a few decades, China's policy has emphasized top-line growth at all costs. But that growth is placing stresses on China's systems and infrastructure. As it is doing with it high-speed trains, China may have to slow down the pace of its economic locomotives. And that's the latest concern about China. On Monday, the Shanghai Composite Index fell for the eighth straight day. The reason, according to the Wall Street Journal: "concerns high inflation will drive Beijing to policies that could slow economic growth."

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His most recent book is Dumb Money: How Our Greatest Financial Minds Bankrupted. the Nation.