The Striker Report

"The great difference between our western Christian world and the atheistic Communist world is not political, gentlemen, it is moral", US senator Joseph McCarthy told an assembled crowd in Wheeling, West Virginia in February of 1950.

"Today we are engaged in a final, all-out battle between communistic atheism and Christianity. The modern champions of communism have selected this as the time, and ladies and gentlemen, the chips are down--they are truly down."

At the time, McCarthy and the cold warriors of the era had made political hay out of the question "who lost China?" when the world's most populist nation fell to Mao Zedong and his communist associates in 1949.

If we could travel back in time and inform the senator that not only would the west make peace with communist China, but that by 2010 the Chinese government would be the second largest foreign holder of US treasuries, it's fair to say that the anti-red crusader would probably be astounded.

But the end of the Cold War did not bring an end to alarmist rhetoric regarding China.

Indeed, the economic rise of the Middle Kingdom has inspired dire predictions of a world-wide takeover – a fear not without some basis in fact.

In August of this year, it was reported that China has overtaken Japan to become the world’s second largest economy. The International Energy Agency estimates that China has just surpassed the United States in overall energy consumption. China has been gobbling up resources from Africa to South America. The rhetorical response to China’s rise from Western media has been predictably hysterical.

"You Better Learn Mandarin Now!" shouted a recent headline from Business Insider.

"China has now become the biggest threat to the global economy" announced Britain’s Daily Telegraph in a 2009 opinion piece by Ambrose Evans-Pritchard:

"Credit has exploded. Allocated by Maoist bosses for political purposes, it has become absurd. China is rolling as much steel as the next eight producers combined. It is churning more cement than the rest of the world. Fixed investment is up 53pc this year. Once you know that Hunan authorities have torn down two miles of modern flyway so that they can soak up stimulus by building it again, or that the newly-built city of Ordos is sitting empty in Inner Mongolia, you know what must come next."

Former Morgan Stanley analyst Andy Xie concurred: "China's property market is a massive bubble."

Indeed, China bears have been licking their chops for some time now, eagerly awaiting the seemingly inevitable implosion.

They may be waiting a while longer. China's housing "bubble" in no way resembles the American phenomenon – there is no significant mortgage securitization in the market, and buyers are typically required to put down 20% up front. Demand for housing – at least in the major cities - remains firm. China's banks are controlled by the government which keeps them on a short leash. While non-performing loans are an issue, a general lack of leverage keeps them from upsetting the apple cart. With $2 trillion in reserves and a robustly expanding economy, the China juggernaut appears to be unstoppable.

Having leapfrogged Japan, will China then overtake the US?

It's possible. But China has some structural issues which have already begun to manifest, and the US has some hidden strengths that have been obscured by the recent financial crisis. Here are some key obstacles that might slow China's ascent:

China has only one-fifth as much water per capita as the United States. Chinese industry uses 4 to 10 times more water per unit of production than the average in industrialized nations, according to the World Bank.
Nearly 500 million people lack access to safe drinking water, and environmentalists have rated one third of China's river waters unfit for industrial or consumer use, according to the New York Times.
China's northern region is facing increased threats of desertification, while what little forested area remains is rapidly being depleted due to industrial and agricultural use.

Then there are China's pollution and health issues:

China's State Environmental Protection Administration (SEPA) concluded in June 2006 that environmental degradation and pollution cost the Chinese economy the equivalent of 10% of GDP annually.
A report by the Chinese Academy of Environmental Planning in 2003 estimated that 300,000 people die each year from ambient air pollution, mostly of heart disease and lung cancer. According to the World Health Organization, 74% of the population lives in areas where air quality does not meet global health standards.
While tobacco use has declined in the US over the last several decades, 57% of Chinese men are smokers, including 6 out of every 10 doctors and university professors. In all, tobacco kills a million Chinese a year, a figure that is expected to double by 2020.

Finally, China's export-driven growth may be a shaky foundation to begin with. Chinese policy makers have realized that they need to boost domestic consumption, but as economist and veteran China observer Michael Pettis recently put it in Foreign Policy magazine, "China cannot enjoy the double-digit GDP growth generated by low wages, cheap capital, and an undervalued currency and still have strong domestic consumer demand."

What's more, China's advantages in labor are gradually dissipating as workers demand higher wages, and going forward, Chinese policy makers may be increasingly forced to turn their attention toward domestic problems of labor, health and environment.

It has become customary to assert that the world's economic center of gravity is now shifting east thanks to American over-extension. And it is certainly true that the US faces a number of economic challenges in the near future. But American freedom still bears rich fruit in the form of creative enterprise – it was, after all, the Americans who invented the Internet, who put a man on the moon and who continues to dominate in science and technology. China's rise may be inevitable, but it would be unwise to count the US out just yet!