Montreal, Canada

The global economy is pinning hopes on a strong and sustainable Chinese recovery. Conventional wisdom now accepts a powerful, liquidity-driven recovery underway in China this year as GDP expanded by 7.1% the first six months of the year.

More than ever, markets have seen their daily correlation increase based on the economic events unfolding in Beijing at the expense of a de-leveraging process still underway in the United States. Wall Street is no more; effective power has been transferred from New York to Washington since last year as big government calls the shots.

Over the next 25 years the world's economic might will continue to shift from West to East as China eventually supplants the United States as the world's leading economic power and largest creditor nation. This process is now underway. The United States won't lose its pre-eminent global status overnight; it took Great Britain more than 100 years to lose its undisputed global status, including two world wars that bankrupted the nation. Massive deficits buried England and they're destroying the United States.

America is following in England's footsteps since late 2007 as the ultimate challenge for global leadership will probably result in a major conflict as the balance of power shifts from Washington to Beijing. Indeed, China already owns more than 40% of all outstanding U.S. Treasury supply and is overwhelmed by the long-term challenges to reduce its U.S. dollar holdings – now in excess of $1 trillion dollars and growing. China has grown more vocal about its massive U.S. holdings this year -- asking Washington for some sort of "guarantee" on Treasury debt.

But if China holds America by the economic chains then its own circumstances might eventually result in a crisis down the road as unused industrial capacity comes home to roost once its $586 billion dollar fiscal outpouring is eventually exhausted.

Beijing's insistence that GDP grew by 7.1% over the first half of 2009 is highly suspect considering that coal consumption by Chinese power plants fell 8.9% and usage of petroleum by-products (including gas) fell 2.6%. I pointed out these dubious statistics earlier last summer as outlined by London-based Horseman Capital, who suggested China's statistics are manipulated.

If the above figures are true -- and I suspect they are, then how can oil prices trade north of $80 a barrel in late 2009?

Chinese inflation, if we believe the figures, suggest CPI is down about 2% year-over-year while wholesale prices have plunged about 8%. China is still wrestling with deflation as demand for its low-cost goods has not increased from traditional buyers in Europe and the United States.

Government spending is what's supporting an economic recovery because domestic consumption in the West has collapsed over the last 12 months and won't recover to pre-2008 levels for a long time. The only major factor supporting Chinese exports is a highly competitive non-convertible currency that has plunged almost 20% since March against the EUR and other major units. China is benefiting enormously from a cheap currency that remains semi-pegged to the dollar.

If deflation is apparent in consumer and wholesale prices across China then the opposite is true for domestic bank lending, bank credit creation (M2), real estate speculation and of course, the Mother of all financial bubbles, Chinese stocks. China is grappling with an out-of-control credit boom that will end badly. The markets don't expect such an event and that's why one of the best speculations over the next 6-12 months remains shorting or betting against Chinese equities.

European and American savings rates will continue to rise. Without both export markets returning to their pre-crisis vibrancy China's economic recovery will run out of gas. The EU and the United States comprise more than 45% of Chinese exports; with consumption still tepid in both regions Beijing is responsible for the lion's share of economic recovery in 2009. Yet China can't be expected to spend another half a trillion dollars in 2010 or 2011 once this sugar rush fades.

During the summer U.S. households reduced outstanding consumer credit at the highest rate in almost fifty years. Without a spendthrift American consumer going forward China's economic miracle is probably headed for disaster. Economic history supports this view as even the United States endured severe economic crashes in the 1890s, 1907 and in the 1930s before truly emerging as the world's greatest economic power since the Roman Empire after WW II.

China's long string of economic miracles will come to a crushing end before she finally assumes her title as the most powerful economy of the 21st century. Short Chinese stocks.