Chinese economic growthOptimism about the American economy is mounting on Wall Street, and some pundits have gone as far as declaring 2011 as "the year of the USA." But when it comes to the year just about passed, it's hard to think of another country that saw its star rise as fast as China.

While the U.S. struggled with near-10% unemployment, China grew at that same pace over the year as it overtook Japan to become the world's second-largest economy by some measures. That has left much of the American public in awe. Nearly half of the respondents in a recent U.S. poll saw China as the world's strongest economic power, for example.

But investors would be wise to take a measured look at China's role in the global economy. Even as its influence on the world stage grows, the country faces massive internal problems. And that leaves Beijing's leadership in a far more difficult situation than the praise constantly heaped on the country implies.

Chinese Self-Interest Rules

Commentators are often enamored by the clout China's vast coffers of foreign reserves give it. But China needs to use those funds to keep the world economy stable as much as any other country. Last week, China's campaign of checkbook diplomacy picked up more steam after the country pledged to buy European bonds in order to stabilize the euro.

Much like Chinese efforts to stabilize Greece over the summer, Beijing would like to cast the move as another demonstration of the benevolent and responsible role China is playing. But the strategy is at least as much about Chinese self-interest as it is generosity. China counts the EU is its largest trade partner and its second-biggest export market.

The same goes for China's approach to U.S. government bonds. While plenty of commentators love to howl about an inevitable dumping of American debt, China nevertheless continues to stockpile U.S. Treasurys. After all, it can't afford to upset the applecart when it comes to its major trading partners because a meltdown in foreign markets would send shockwaves across the heavily export-dependent Chinese economy.

A Lack of Innovation and Creativity

Some prominent domestic commentators are pointing to the flaws of the Chinese economy even as the rest of the world grows increasingly impressed. "China's rapid growth has been achieved at an extremely high cost," Yu Yongding, a former member of the People's Bank of China's monetary policy committee recently wrote. "Only future generations will know the true price."

Some of Yu's criticisms have been frequently made before. For example, high-profile American short-seller Jim Chanos has railed about the country's massive make-work investments that may ultimately result in vast amounts of poorly allocated capital. But Yu says a more fundamental lack of innovation and creativity are the "Achilles heel" of the Chinese economy.

On the diplomatic front, too, China faces staggering limitations even as its overall influence grows. By investing in politically sensitive and labor-intensive sectors abroad like the Greek shipping industry, for example, China is again using its funds to buy influence.

Why So Easy on North Korea?

And yet China has shown far less ability to influence events in its own backyard than might have been expected. Beijing has stood by largely quietly even as a reckless North Korean regime reliant on its patronage embarked on a series of provocations that analysts say have led to considerable embarrassment.

But in this case, a fear of instability seems to be binding Beijing's hands. China seems to be unable to risk a refugee crisis or publicly chastise a fellow authoritarian regime. Instead, it took a newfound toughness on the part of South Korea along with the U.S. to stabilize the region (so far, at least).

Markets tend to get carried away. Sentiment in the U.S. is getting much more optimistic, even though the most-heard alarm not long ago was that the domestic economy would be stuck in the mud for years.

China, on the other hand, can do little wrong for the time being. But investors should be aware of the vast economic and political limitations the country faces despite its red-hot growth.

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12 Comments

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bfpowersjr

Mr. Kumar: I agree with the tenor of your article. A few decades ago some pundits thought that Japan might rival the U.S. economically

December 28 2010 at 3:39 AM Report abuse rate up rate down Reply
Rod3putt

while I do agree , government should be curtailed, please be aware it does not restrict our producers ! production in this country is becoming non-existent ! slowly and surely over the past 30 years production has been outsourced ! blame the unions ? I guess there members should be willing to work for $2.00 a day ?

December 27 2010 at 5:52 PM Report abuse +1 rate up rate down Reply
Robert & Lisa

The solution is very simple. Restrict government instead of restricting our producers which restricts our standard of living. More and bigger government means less food, clothes and other goods for everyone= lower standard of living. Ever wonder why evil, ultra rich men like George Soros support the unions and the corrupt Demoncrat politicians? Somebody is deceiving somebody...

December 27 2010 at 5:30 PM Report abuse rate up rate down Reply
Sonny

Blame it on corporate America...............Blame it on anyone, but it is a fact that America cannot afford the unions, especially those in the public sector that demand more pay and pension benefits than we make in the private sector. Keep on taxing us and keeping us at poverty to pay for the rich ways of the unions, soon you will have nothing. It is very clear, but in order to gather votes, the politicians have ignored us.

December 27 2010 at 5:20 PM Report abuse +1 rate up rate down Reply
1 reply to Sonny's comment
GAYLEN

Biggest problem is Wall Street, no long term planning. Just short term profit and blame everyting on someone else. Just look at how CEO bonuses is out of control, upper and middle management wages is way to high for the work that is being done. Just to many Blackberry,I-phones and texting to get any work done.

December 27 2010 at 5:38 PM Report abuse +2 rate up rate down Reply
carol lowery

China may be where we use to be but they do have problems. Already, the workers are demanding better working conditions and better pay so here come the unions if the government doesn't do something to prevent it but the power of the people could overcome it. I read an article where it is already occurring along the coast but not inland. Also, there is no control on product safety, we have seen tainted pet food, lead in kids toys, wallboard problems seen a lot here in Fla. We really do need to do something to control unions and some of that is already occurring but when our own govn is all unionized with better pay, benefits and pension, that also brings problems. We can not stand on "green" alone, we need jobs for a lot of the average people who did so well in our factories for years and we need to try and start making some of our own products here.

December 27 2010 at 4:21 PM Report abuse +2 rate up rate down Reply
carol lowery

China may be where we use to be but they do have problems. Already, the workers are demanding better working conditions and better pay so here come the unions if the government doesn't do something to prevent it but the power of the people could overcome it. I read an article where it is already occurring along the coast but not inland. Also, there is no control on product safety, we have seen tainted pet food, lead in kids toys, wallboard problems seen a lot here in Fla. We really do need to do something to control unions and some of that is already occurring but when our own govn is all unionized with better pay, benefits and pension, that also brings problems. We can not stand on "green" alone, we need jobs for a lot of the average people who did so well in our factories for years and we need to try and start making some of our own products here.

December 27 2010 at 4:21 PM Report abuse rate up rate down Reply
pcakepal

It is sad beyond the most unimaginable of all possible considerations, this non-stop shameful babble of excuses attempting to paint U.S. leadership incompetence for other than what it is...

Having been to China several times, conducted sizable business dealings there and seen the end result of a collective dedicated work ethic from the very highest leader to the dirt poor peasant, then comparing our general attitude and current state of affairs across the board, there can be no mystery in this person's mind I can assure you, what economic ugliness holds forth for the year 2011 and many thereafter, no matter the White House or Wall Street propaganda.

Like it or not, given the debt service vig, we all working for China, hahaha!

December 27 2010 at 3:25 PM Report abuse +1 rate up rate down Reply
WILLS

China is moving forward much in the same manner as the U.S. in the early 20th century, and with it comes all of the same obstacles. Some of this has been evidenced in the toothpaste with ethylene glycol and tainted milk. Couple this with a mostly poor rural population and food price inflation, not to mention shortages, is a bad mix. Real estate prices are still on the rise and this has bubble potential. The recent failure to meet short term debt sales targets was the third this year. Everything is not as well in China as most think, or at least a careful analysis points in this direction. One should also keep in mind that China is the supplier of North Korea in the way of food and China has a serious problem in just feeding it's own population. One thing about food - constant demand.

December 27 2010 at 1:53 PM Report abuse rate up rate down Reply
1 reply to WILLS's comment
Robert & Lisa

Not really. They are restricted by a socialist government. Unfortunately, our government is becoming more socialist which will hurt our ability to compete.

December 27 2010 at 5:26 PM Report abuse -1 rate up rate down Reply
bohemianacres

One thing to remember as hinted at in the second closing paragraph, sentiment is a feeling. It does not produce economic ups or downs. Whereas, in China's case, money in some form or another, does produce economic ups and downs. That is where China is at right now. That is also where the U.S. is right now too, mired down because everything is talk but no action. As long as we are in talking mode, and China is in money mode, they will always be coming out ahead. About North Korea and China's reaction, two things come to mind. As long as the attention is on N. Korea, it is off China. Besides, China knows as the old saying goes, arm every Chinese with a pitchfork, and they can beat anyone. It appears arming each Chinese with a yen, and they can beat any other country's economy too. My stakes are on China being the "Country of the Year" in 2011 also.

December 27 2010 at 12:30 PM Report abuse +1 rate up rate down Reply