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China: Economic Miracle or Just Another Bubble?

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China's surging, rampant capitalism is still only skin deep - but probably for good reason.

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"Do you think China is really an economic miracle or do you think it's just another bubble"?

Well isn't that the million dollar question. I was emailed this question a few days ago by a Minyanville reader who follows my China columns, along with a request for more general insight on how this crazy quasi-capitalism arrangement works, particularly in regards to the complicated housing market and banking sector.

If you think China is difficult to understand from abroad, you can't imagine how much more complex this place gets once you're here. Enormous wealth coupled with mass construction and infrastructure development completed in the blink of an eye captures the hearts of those who take a trip here seeking to find the China miracle.

But beneath the surface lies a twisted economy heavily intertwined with tight government control and rampant corruption that runs deep throughout the society.

The longer you stay in China, the more questions you have. And the more answers you stumble upon, the more confused you become -- partly because there are limitations on what can be openly discussed.

That said, the email I received made me realize that many westerners don't really understand the basics (if that word is really appropriate here) of China. Thus, I'll walk through the fundamentals of understanding how this country operates and provide a background on some of the key segments driving expectations of China's future.

The streets of China demonstrate capitalistic behavior. Privately run shops compete for business. Motor scooters roam around negotiating prices to take you where you want to go. And ads for foreign brands clutter the sky (at least in larger cities)

However, evidence of capitalism begins to taper off from there. The government still controls the majority of the economy and society. From the banks to the media to the land, the government owns it (or in the banking sector, at least most of it).

While the Communist Party has opened China to capitalistic ideas to generate economic growth, it still ultimately determines who survives and who doesn't. Survival of the fittest -- the fundamental notion of capitalism -- is an unknown concept.

This becomes blatantly evident in China's competition with foreign business. Because China still lacks innovation and technology creation skills, it remains a copy-cat economy. In many cases, it welcomes western businesses into the country to operate, strategically partners with them (typically via a JV), copies the product to create a domestic competitor and then pushes the western business out of the country.

Wonder why I can't access Facebook, Youtube (GOOG) and Twitter here? It's certainly not because of the "political openness" issue the government claims. Rather, it wants the Chinese clones that were built on these models to thrive. RenRen, an exact replica of Facebook, experienced a surge of subscribers as soon as Facebook was blocked. Yukou and Tudou, China's version of YouTube, are now announcing intentions to go public on the Nasdaq in early 2011.

It's also transparent in the banking sector. To understand China's banking sector, look no further than the US financial crisis. The bailouts of 2008 that caused uproar among US citizens arguing a capitalistic society must face the penalties associated with taking on too much risk, essentially depicts how the Chinese economy operates on a full time basis.

Ask a Chinese banker what risk management is and you're likely to draw a blank face. It simply doesn't exist.
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