Analyzing the Chinese economy while it's growing at superfast rates is like analyzing a credit card company or a mortgage originator during an economic expansion – all you see is reward – the growth. But the defaults – the risk – are masked by a healthy economy and constantly increasing new business that is profitable at first. The true colors of that growth only appear after the economy slows down and new accounts mature. (In fact, the banks or credit card companies in the US that showed the lowest loan growth during last expansionary cycle have a lot fewer credit problems than those that did – US Bank Co. comes to mind here.)

The consequences of LSGO are likely to be very painful for China. As of today we don’t know how much of the recent growth came from wasteful, unproductive growth. Only after a slowdown will the true problems surface.

Speed: What makes things even worse is that China cannot afford a slow down. I discussed this in the past but it's worth repeating. The Chinese economy is like the bus from the movie Speed. In the movie the bus is wired by a villain (played by Dennis Hopper) with explosives, and will explode if its speed drops below 50 miles per hour. The Chinese economy has 1.3 billion unsuspecting people on board. It could blow if economic growth drops below its historical pace.

A combination of high financial and operation leverage sprinkled with past high growth rates will send this economy into a severe recession if growth rates slow down. Let me explain:
High operational leverage. China has become a de facto manufacturer for the world. With the exception of food products, it is difficult finding a product that was not, at least in part, manufactured in China. Industrial production accounts for 49% of GDP, double the rate of most developed nations (i.e. industrial production for the United States is 20.5 % of GDP, UK 18.2%, and Japan 26.5%).