China's Olympic spark may mask a ticking time bomb

China's Olympics may be important milestone in its ascent, but assured economic prosperity is a long way off.

China's leaders are a bland lot, all poly-wool blends and comb-overs, but for the next two weeks they'll bask in the glory and pageantry of the Olympic Games. When it's all over, they'll go back to their day jobs: navigating what is in many ways the world's most important economy through a turbulent global marketplace. Don't let the dazzling opening ceremonies and Beijing's gravity defying new skyline deceive you. China may well be a budding hegemony, and the Olympics an important co-ordinate in its ascent, but it may also be a ticking time bomb.

China's stunning economic growth - it expanded by 10 per cent in the first quarter - is finally taking its toll on consumers. Inflation is growing by nearly nine per cent, a 12-month high despite the growing value of China's currency, the yuan, and it shows no signs of slowing down. The prospect of further yuan appreciation attracts a steady inflow of speculative investment that only chases prices higher and makes Beijing's tight money policies more expensive.

Because China's bond markets are underdeveloped relative to liquidity rates, the government has only limited policy options at its disposal. It can raise banks' reserve requirements, as it did recently, but such a ham-fisted response usually chases funds out of the official banking sector and into the country's vast underground lending markets. The result is sustained property investment, either for personal use or speculation, at a parlous rate: home purchases in China's 70 largest cities were up 10 per cent for the year to June. Mortgage lending accounts for about 12 per cent of the country's gross domestic product, and that figure is based on what's reported; the actual ratio is probably much higher.

Should China suffer a US-style housing collapse, it could trigger a banking crisis in a country where non-performing debt is already an estimated seven per cent of outstanding loans. And therein lies another dimension to China's vulnerability: the country's finance houses, for decades nothing but lending windows for state-run companies, are sitting on a mountain of unpaid loans. If the US recession infects China, bank failures could become painfully commonplace. Businesses would collapse and unemployment rates soar. Given China's generous subsidy systems - it spends about one per cent of its gross domestic product on the energy sector alone - a banking crisis would require a massive bailout of consumers, banks and business owners.

Fortunately, China has a trillion-dollar war chest in foreign exchange reserves to draw from. But the damage a major economic crisis would have on the leadership's reputation for competent management would be lost. Since the bloody silencing of China's pro-democracy movement in 1989, Beijing has redeemed itself with a 20-year economic expansion that has lifted more people from poverty than at any time in history.

Having assumed the burden of decision making for the welfare of its citizens, China's leaders deserve credit for enriching an economy of 1.4 billion people. But having deprived them of anything other than material gain, Beijing will have little to offer should the economy finally buckle under the strains of relentless growth. A recent poll conducted by the Pew Research Center revealed that eight out of 10 Chinese people are satisfied with their government, despite an underlying concern about inflation and economic security. The average Chinese, if he thinks about the Olympics at all, considers them righteous deliverance from centuries of humiliation at the hands of foreign powers.

It matters not that in the past few weeks, dissidents have been jailed or fled into hiding. Nightclubs have been shut down, travel visas have been revoked and contentious places, from Tibet to Tiananmen Square, have been declared off limits for visiting media. In that sense, the 2008 Olympics are shaping up to be less a coming-out party for a "new" China" than a requiem for the idea that favouring dictators with an international covenant would be positively reciprocated.

If there is something vulgarly materialistic about the Beijing games - a lavish party thrown as an excuse for showing off newly earned riches - the Chinese people don't seem to mind. All the regime has to do is hold up its end of a transaction - despotism for wealth creation - that has worked so well in the past two decades. And that is shaping up to be the most Olympian challenge of all. [e-mail]