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It’s been one world economically, a global village, for years now.

The competition between major countries is no longer fought on the high seas, or on land with vast armies, but in board rooms and markets. That China is a communist country politically is no longer a concern. The competition is economic, for instance whether China’s semi-capitalistic economy, having already surpassed France and Germany, will soon surpass Japan to become the world’s second largest economy behind the U.S.

The big concern in the U.S. is not which country has the largest navy or nuclear arsenal, but whether China, Japan, and the oil exporting nations, will continue to buy U.S. bonds, and hold U.S. dollars in their central bank reserves, happy to be the largest foreign holders of U.S. debt.

The global village aspect and intertwined economic dependence on each other can be seen in the way global economies enter and exit recessions together, and see their stock markets enter and exit bull and bear markets together.

It should be no surprise then that the economic worries blowing over Europe this year have circled the globe.

Chill winds picking up in China haven’t attracted as much attention yet, but may soon.

China’s economy has been growing at a blistering pace for years, which has not escaped the attention of global investors. China’s stock market gained 600% from its low in 2005 to its high in late 2007. It then plunged 72% in the global bear market of 2007-2009. And it subsequently surged up 107% in the new bull market (while the U.S. market gained ‘only’ 80% to its recent peak).

However, there hasn’t been much recognition that the Chinese stock market topped out again last July, and has now declined 27%, officially in another bear market, even as its economy remains one of the strongest.

Stock markets typically look ahead six to nine months and react now to what they expect economies to be six to nine months in the future. Is China’s stock market forecasting trouble ahead for the Chinese economy?

That’s an important question given how important China’s booming economy has been to still fragile global economic recoveries. Prosperous Chinese consumers are sucking in the exports of other countries at such a pace that China’s imports at the end of March were 65% higher than a year ago (creating China’s largest trade deficit in over six years).

So, where is the potential problem that has had the Chinese stock market concerned since last July, well before the debt crisis in Europe popped up as an additional worry?

It is probably that real estate in China is in a bubble, and stock markets know what bursting real estate bubbles do to economies. Property prices in China have been rising sharply for several years and soared at a record pace in March, up an average of almost 12%, but more than 50% in some overheated cities, from a year earlier.

The Chinese government is obviously worried, and trying to let the air out of the bubble in a controlled manner. It has raised the amount of reserves its banks must hold, thus discouraging lending, raised mortgage rates and the size of required down-payments. Most dramatically it is now requiring 40% down payments on second homes in an effort to halt the rampant ‘flipping’ of real estate for quick profits by speculators.

Large global investors like BlackRock, the huge New York mutual fund group, and Boston’s State Street Global Advisors, are among the sellers of Chinese stocks, BlackRock indicating it believes China’s economic growth has peaked, that the efforts of the Chinese government to cool off its real estate industry will have a negative effect on the overall Chinese economy.

That does make sense. A booming real estate market has an outsized effect on economies, creating jobs and business for all manner of supporting industries; producers of construction, electrical, and plumbing materials, furniture and appliance manufacturers, carpet and candlestick makers. Letting air out of the real estate bubble in China is no doubt necessary, but raises uncertainty about China’s overall economy, which is now more than ever of importance to fragile global economic recoveries.

The economic storms in Europe are more than enough potential problems to keep investors occupied, but the economic clouds potentially forming in China also need to be watched.

Disclosure: No positions

Source: China: The Next Ill-Wind?