A lengthy, but essential post from James Waterton at Samizdata:

I believe that the Chinese banking sector’s dire straits constitute the gravest threat to global stability in the coming years. The Chinese government is always harping on about its “deepening” banking and state-owned industrial enterprise reforms, and this is a mantra is being repeated across the world. Unfortunately, the Chinese state is so opaque that it’s impossible to verify the veracity of such claims, and the unrealistic numbers being thrown at us by the Communist party (like the drop of NPLs from 25% to 12% in less than five years) and the shonky juggling of bad debt from one insolvent bank to another woefully undercapitalised holding company do not inspire much confidence in the nature of the reforms. Frankly, I believe the banking sector is too far gone to reform without collapse. In international terms, the crisis in the Chinese banks and SOEs is an elephant that stands in the middle of the room, but everyone is either perceiving it as a mouse or trying to pass it off as a mouse. I believe the Australian government is in the latter category, as are a great many others around the world.

I have been cautioning against this for years – urging those interested in “emerging markets” to look to the more stable and liberalized nations of Ireland and Eastern Europe. The Chinese economy is as flimsy as rice paper. This is akin to Japan in the late ’80s, but far worse. Japan has a substantially free market. The free market in China is a sham.

It positively escapes me why such normally intelligent libertarian investment advisors as Capitalist Pig’s Jonathan Hoenig have been so bullish on China.

Mentioned only tangentially by James in this article is the fact that, while their holding have been greatly reduced this past decade, the Red Army is an economic entity unto itself. If the domestic financial situation takes a sour turn, it may feel the need to engage in foreign adventurism – particularly if it could be “profitable”. Ownership of the Spratly Islands in the South China Sea have long been a point of contention

“Without going to the Spratly (Nansha) Islands, you would not know the magnitude of the threat and challenge to China’s maritime territory and interests” – People’s Liberation Army Daily reporter

Oil and Gas reserves in the region are unknown, but suspected. If the Red Army suddenly becomes unable to supply its fuel needs due to an economic downturn, the pressure to secure control of the region will increase greatly.

As James makes quite clear, even if no blood is shed as a result of the Chinese bubble bursting. the global economic effects would be harsh. Australia (James’ homeland) would be particularly hard hit, as much of it’s economy revolves around supplying China with raw materials.