While everyone knows the story about China and its enormous growth potential, few take the time to consider the scope of the change that has already occurred there. Chinese statistics have often been criticised for being less than accurate and even key political figures, such as Li Keqiang, First Vice-Premier for the People’s Republic of China, have noted that official Chinese GDP figures are “man-made” and “for reference only” (http://www.wikileaks.no/cable/2007/03/07BEIJING1760.html).So we should consider most statistics with at least some scepticism. In fact, most sell side analysts from major investment banks seem to gloss over all the burgeoning issues brewing in China (eg environmental pollution, social unrest amongst migrant workers and an over-heating real estate market), instead they prefer to focus on the “long-term dynamics” of what China will become. Again, we have all heard the story: a rapidly growing middle class in excess of one billion people will be formed over the next 30 years who will need refrigerators, cars, iPads etc. In comparison, it took Europe and North America almost 250 years to develop a middle class of some 600 million people so this explosive shift is, in itself, awe inspiring and the long-term investment opportunity does seem virtually indisputable. The importance of the “China Story” is immense because it is one of the key factors underpinning a great deal of growth in almost every sector of the global economy.But what happens if we stop for a second and look at what has already happened at this stage? Let’s consider a few statistics to see if China may be “getting ahead of itself” and may be overheating:l Housing affordability for residential properties is hitting stratospheric levels. Properties now trade hands in excess of 20 times disposable income in cities like Beijing and Shanghai. Note: Tokyo peaked at eight times disposable income at the height of its property boom and the US peaked at a paltry 6.5 times. Smaller, Tier 3 Chinese cities, however, are not priced as dramatically and exhibit pricing at a more reasonable three times disposable income. Stated another way, China’s property investment in 2009 reached 10 percent of GDP, in comparison to nine percent of GDP in Japan and 6.5 percent of GDP in the US at the peak of their respective property bubbles, according to Citi.l Rating Agency Fitch recently downgraded its outlook on China’s local currency debt rating sighting “elevated credit growth, the sharp rise in real estate valuations, and more recently the emergence of inflation pressures have...increased the risks to macro-financial stability”. Fitch also mentioned China’s banks could see bad loans reach 30 percent of their portfolios.l Moody’s on July 5 stated that Chinese bank loans to local governments are about $540 billon more than the national auditors estimate, and the banks industries’ credit outlook could decline. The rating agency also mentioned that because of sloppy underwriting and other problems, up to 75 percent of these loans could go bad. This would essentially push the bad debt ratio for Chinese banks up to the eight percent to 12 percent range of all loans instead of the one percent bad loan ratio now officially calculated.l The extent of China’s investment boom has never been witnessed anywhere in the world. Investment as a percent of GDP runs at nearly 50 percent in China. According to Societe Generale Cross Asset Research, China is consuming 1,400 kilogram of cement per head per annum, more than four times higher than the world average and greater than the previous record level consumed by Spain prior to its housing crisis. In fact it has been estimated that China produces and consumes slightly less than 50 percent of the world’s total cement.l How about the urbanisation story? Well, again according to Societe Generale, China is building almost two billion square meters of new housing per annum, well in excess of the demand created by the 20 million workers that are migrating to the cities each year. Real estate investment in China has averaged an outsized growth rate of 25 percent over the last eight years and even accelerated to 34 percent in the first quarter of 2011.l In addition to the growth in residential properties being built, Jim Chanos of Kynikos Associates has revealed a shocking statistic: “There’s currently 30 billion square feet of Chinese [non-residential] real estate in the works, which would work out to a 5 x 5 cubicle for every man, woman, and child in the country.”l Institutional Investor Magazine recently has indicated that China now imports about 10 percent of the world trade in oil, 11 percent of coal, 22 percent of copper, 23 percent in cotton 55 percent of soybeans and a shocking 87 percent of iron ore.l Economists now are estimating that inflation for China will climb to 6.2 percent year over year in June, according to Bloomberg, up from 5.5 percent in May. This is far in excess of the government’s official target rate of four percent.The risk with all this rapid growth and explosive investment is that it may have been done with little regard for the returns it will generate and the incremental efficiencies it will provide. Any significant slowdown in the rate of growth for Chinese construction would have serious negative follow-on effects for commodity prices and industrial product sales. It would also negatively affect those nations whose wealth and growth in GDP is closely associated with commodity demand from China like Australia, South Africa and Brazil.In investing it’s the “unknowns” that get you. It’s the stuff hiding in the dark side of the moon that is ignored because the glow from the bright side is so mesmerising. The long-term growth story of China is very compelling and often quoted but its darker side needs to be considered as well.