The China Question: How Will the Country's Economic Difficulties Impact the U.S., Other Global Powers?

The debate on whether China is about to implode as the next big economic bubble bust or not continues to rage, but even the most bullish on the Asian economy must admit there's fire behind this billowing smoke cloud. The question then becomes only what the impact will be to America and other world economic powers.

Just this week, China's communist government announced that local governments in the country have piled up debts of $1.6 trillion, raising concerns of banks' health in the nation if the loans can't be repaid. The money was borrowed by local governments throughout the country during the boom period of the last decade as China's economy has emerged fast to become the world's second largest, bypassing Japan, to pay for construction and other spending.

Analysts acknowledge some local governments might not be able to repay loans, but they suggest massive default and meltdown iss unlikely since state-owned banks in China have plenty of cash and are not mortgage-debt ridden like so many Western banks that were hurt in the 2008 meltdown.

Still, few officials saw the scope of the financial crisis coming that struck the U.S. in 2008, spreading globally and requiring governments including the U.S. and throughout Europe to step in with emergency spending and loan programs for banks to avoid a cataclysmic meltdown. And, even the report made by from China's communist government about the local-agency debt issue facing the country stated that some local governments in China would not likely be able to repay loans.

The total sum of $1.6 trillion is significant, even for China.

Due to inadequate repayment ability, some local governments can only pay their debts by taking on still more debt, stated the report, provided by China's National Audit Office.

Bank lending domestically was a significant part of China's economic stimulus package during the global recession. Beijing contributed an estimated $586 billion in stimulus, buoying the Chinese economy, yet that is only a portion of the money borrowed by local governments and agencies over the last decade. According to an Associated Press report, American researcher Victor Shih of Northwestern University estimates local government borrowing in China between 2004-2009 at $1.6 trillion.

China's state-owned banks are among the world's largest, with estimates suggesting they have $1 trillion in assets. At issue is whether or not China has a housing bubble that is set to implode, setting off spiraling effects that cause larger defaults by local governments than many officials are predicting.

Now that China has passed Japan to become the world's second largest economy and the country is the leading low-cost goods provider to the U.S., and also among the largest holders of American debt, the issue merits close watching for U.S. companies and heavily-invested individuals who could be impacted by a large scale financial meltdown in China.

Hedge Fund Manager Chanos Sounded Alarm in 2010

In the mainstream media and investment world, the question of whether or not China is the next big economic bubble to burst gained momentum in late 2010 when renowned short seller Jim Chanos, the hedge fund manager who correctly called the implosion of Enron, Tyco, and sub-prime mortgages while the rest of Wall Street continued to pour money and praises upon both. Chanos appeared on Bloomberg's Charlie Rose program late last year and said China was on an economic treadmill to hell.

Neither Wall Street or China liked the message, and when Fortune did an interview with Chanos about his sentiments, he jokingly said because of his nay saying reputation in China it is best he doesn't go there, or he can envision the media headline: NEW YORK INVESTOR KILLED IN MYSTERIOUS ONE-MAN EARTHQUAKE.

But the reality is that Chanos began questioning China's economic foundation as early as 2009, when one global company after another was at the height of pouring billions into the economy through partnerships with the country's communist government. He told Fortune he and his company began looking at commodity prices and the stocks of big mining companies. The result: Everything we did in our microwork (on commodities) kept leading us back to China's property market.

Chanos recalled being at a research conference in 2009 when an analyst enthusiastically cited numbers of China's robust building boom, noting that the country was experiencing building at a pace of 5 billion square meters of new residential and office space, on top of all that had previously been constructed in the country during its emergence over the past decade and before the globally-hyped Beijing Olympics.

Chanos did some math. He calculated the pace would result, divided by China's population of 1.3 billion people, at what amounts to one five-by-five cubicle for every man, woman, and child in the country. That's when he began to play the drumbeat of a contrarian, stating flatly he sees China heading for economic bust.

China's Housing Bubble is Apparent

The sentiment echoes the thoughts of one U.S. advertising executive who traveled to China in early 2010 for work. He had never been there before, and was studying advertising, not economics. Neither does he profess being an economics expert. beyond what experience keeping an agency afloat in the Great Traditional Advertising Depression that began in 2008. As most first-time visitors to China, he drank Starbucks coffee and dined on animals, and animal parts, he had never eaten before. Otherwise, he was not struck by the unusual, noting that the people of the country were just like us, trying to earn a living each day and provide for families, except for the obvious housing bubble, which got his attention.

You see it all going up so fast, he said. I know wages aren't keeping up with that. How can they afford all these houses?

Still, optimism about China has reigned. Many who say Chanos and others predicting a meltdown in China are wrong note that personal income has been on the rise in China, climbing by what some estimates cite as 6 to 10 percent, and that Chinese buyers typically put down as much as 30 percent or more of the sales price when making a purchase, providing more equity than U.S. buyers had when the country's housing market imploded in 2008. But inflation has climbed, also, and the 30 percent equity figure is only relative to value of the property, should prices suddenly drop, and an owner's ability to pay the note.

A Bloomberg report this week quoted a former academic advisor to the People's Bank of China who said inflation has stabilized, though, and that prices in the country won't exceed 6 percent in any single month. China officials have also stopped raising interest rates in the country for almost three months now, trying to provide stability against rising costs as the U.S. economy slows from previous growth predictions and the debt crisis in Greece and other European countries grows more concerning.

Communist Government Will Use Necessary Tactics

But the biggest advantage China may have in its future in the battle to avoid a big bubble burst may be its communist government. Since economic bubbles that burst are as much a form of citizen emotional reaction that rapidly drives down asset values in mass reaction to fear, some experts believe the Chinese government will work hard to put a clamp on any such movements to avoid a meltdown.

Peter Morici, a public policy professor at the University of Maryland, addressed this very issue in an interview earlier this year wtih CNNMoney, noting that China could easily bouy its economy should conditions worsen, flooding the U.S. market and world with extremely cheap stuff to provide domestic stimulus support. Although that equation doesn't address rising wages in China that may make such a move more difficult in the future as it was in the past, Morici was convicted that China's ability to make cheap goods, shipping them to the U.S. and throughout the world, provides the country distinct advantage.

Remember, he said, when we talk about bubbles, the stakes are the future of the communist party. They'll try to survive no matter what; and it could mean destroying other economies to do it.

The question regarding China and its bubble then becomes larger than whether or not its economic bubble will burst, but how its financial future will impact the U.S. and other global financial powers into the future since obvious problems do exist.