Have the Chinese engineered a spectacular economic recovery, the envy of the industrial world or has Beijing created a version of the American housing and credit bubble of the past decade?

The China jury is still out. But despite the evident confidence in the mainland story shown by the commodity and currency markets there are worrying signs that the end of the government stimulus spending will seriously dampen the Chinese economic resurgence.

When the Chinese Government announced their four trillion yuan stimulus package ($585 billion, 14% of GDP) last November the world economy was in the acute phase of the financial crisis. Lehman Brothers had just collapsed and falling equity markets would continue to plummet for another four months. The United States had just elected Barack Obama President but he would not be inaugurated until January 20th and any fiscal rescue package for the US economy would have to wait until the new administration and Congress took office.

With the industrial west in financial crisis and western governments already running large deficits the world looked to China for a possible solution. The Chinese Government could use its large cash reserve to reinvigorate her economy. Chinese consumers might then be willing to substitute their own domestic consumption for the exports that were no longer going to their straitened comrades in America and Europe.

China had all the necessary qualities for a successful stimulus: a huge and urbanizing population, a large hoard of disposable cash and a government both willing and pressured to keep its restive population happy with jobs and products.

Fourth quarter economic growth in China had dipped to 6.1% but it came roaring back to 7.9% in the second quarter. Though just under the semi-official goal of 8% that the Beijing government is said to keep as the lower acceptable limit for economic growth, recovery in such a short space of time was a triumph of central government action. But the particulars of the expansion are less than reassuring. Growth appears to be dependant on continued government spending and some aspects of recent economic developments are sensible of bubbles in the stock and perhaps housing markets.

Long term Chinese economic growth is still largely determined by her exports. If the demand for imported goods in the United States and Europe, the Middle Kingdom's most important markets, does not resume, will Chinese domestic consumption be sufficient to absorb the products of China's factories and maintain Chinese employment?

Chinese exports have recovered slightly. In July the trade balance rose to $10.63 billions from June's $8.34 billions. But this year's first and second quarter averages, $20.84 billions and $11.62 billions respectively are a far cry from the $38.10 billions and the $27.78 billions of the fourth and third quarters of last year.

Despite the Beijing Government's public goal of increasing domestic consumption, purchases by Chinese households constitute a similar percentage of the economy as they did five years ago. Non-governmental or private consumption was $1.6 trillions in 2008; by comparison private consumption was $7.4 trillions in the EMU and $10 trillions in the United States. It will be difficult for China to replace western consumption with her own from such a small domestic base. In addition, from a timing vantage private consumption cannot be augmented in the same rapid and ordered fashion that governmental spending can. Not surprisingly the bulk of the Chinese stimulus money has been directed through state organizations and the banks.

Most of the fiscal stimulus to the economy has been provided by loans from the Chinese banking system. New loan commitments have increased by over $1 trillion in the first six months of this year, a 28% rise year over year.

One result of the loan cash disbursement had been a boom in the Shanghai Stock Exchange. From the end of last year until early August the SE Composite rose more than 80%. This rapid price increase raises the possibility that money finding its way into the economy is being used in pursuit of a quick speculative return rather than buying consumer goods or placed as investment in productive assets like factories and stores.

The Shanghai SE Composite has fallen 23% from the August 4th peak, including 2.9% on Friday and 6.7% on Monday. This precipitous fall and the reason for the drop, the news that bank lending had fallen again in August after a steep decline in July, were indications investors are worried that if the available cash dries up the market might have no other support.

The government has supplied subsidies to rural and urban families for the purchase of household electrical goods. But this type of program can only provide a temporary fillip in consumption and a stopgap for the domestic manufacturing sector. When the subsidies expire local demand will tail off because there has been no change in the job outlook for Chinese workers.

Anecdotal evidence from housing markets in various parts of the country also point to the return to home purchase as a speculative investment, as prices in some urban areas have gained substantial amounts since the stimulus cash began flowing. Car sales also have been strong with China recently surpassing the United States as the world's largest auto market.

There is as yet scant evidence and little historical reason to believe that the Chinese stimulus spending has created the necessary conditions for a permanent expansion of domestic consumption, regardless of the dramatic improvement in official economic statistics.

There are two places for Chinese factories to sell their goods, at home or abroad. Unless there is an unexpected revival of consumer spending in China's export markets, it is unlikely the stimulus has created enough stable domestic consumption to absorb the production of China's factories. Without exports Beijing may soon face the need and the dangers of another round of stimulus spending.