One of my themes to watch in 2012 was China. I thought this was going to be a very important year for China, one that generates a lot of debate and dialog. So far, I’d say that this has been mostly correct. Maybe not in terms of the ubiquity and size of the Chinese discussion, but definitely the different dimension.

In case you’re still thinking of China as this rapidly industrializing, cheap-exporting, exponentially growing awesome economy that will soon be kicking the United States to the curb and stealing its lunch money, it’s time to stop living in 2007 and wake up in 2012. The vector has changed.

Bloomberg Businessweek did a great article on this last week. Giving it a read should get you quickly up to speed on the broader points, especially about why all the drama around Bo Xilai matters for economics.

I can’t tell you how fascinating the evolution of this economic story has been to me. Five years ago, I think the word “insecure” accurately summed up the way the U.S. felt about China. That was the context for the discussion back then. Today, however, we’re a lot less worried about what being the #2 economy means — why does it matter if the largest economy in the world is still a very poor nation? — and instead we are nervous that China slowing down may take us with them. Can’t have that, now.  No, sir.

There’s also a newer, stronger component of moral superiority to the debate. Open up the Wall Street Journal and you are repeatedly exposed to commentary about how a “proper” economy ought to be run. Turn on MSNBC and you get a steady stream of human rights stories with China as the main villain.

If you want to take a deeper look at the economic angle and you can clear your schedule for the afternoon, I’ll recommend Hugh Hendry’s latest epic commentary. Hendry runs the Eclectica fund and I used to follow his stuff religiously until he stopped writing and kinda disappeared. This is his first published research since 2010.

In any case, the essence of his argument is that China is speeding towards disaster. I’ve spent a lot of time in this newsletter about negative real interest rates here in this country and the perverse incentives that disquilibria like that can create. But in China the financial repression is far worse and has persisted for much longer. With inflation that usually runs between 7-9% per year and a government-imposed cap of 0.72% on bank deposits, savers in China (a nation that really likes to save, too) is forced to deal with negative real rates of -7%. With that kind of disincentive to save, nobody should wonder why they have a pretty spectacular real estate bubble over there.

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