What's Really Behind China's Economic Growth and Why It Won't Last

When I read some of the headlines by other news organizations, sometimes I can’t help but chuckle at their oversimplification. Other media outlets take a kernel of truth, and ignore the rest of the picture, only to blow that tiny piece of truth out of proportion.

As an example, there was a recent release by the National Bureau of Statistics of China that reported the Chinese economy grew 7.8% year-over-year for the three months of July to September. (Source: National Bureau of Statistics of China, October 18, 2013.)

That headline number for the Chinese economy does look impressive at first glance. Of course, the mainstream media has used that one data point to extrapolate that the economic recovery we are all expecting is close at hand.

However, the Chinese economy is far more complex than simply looking at the headline data point of year-over-year gross domestic product (GDP) growth.

While nothing would make me happier than to finally hear of a real economic recovery occurring somewhere in the world, I’m afraid that the Chinese economy is simply being pushed higher by a government injection of stimulus that will only be temporary.

While America is suffering from a lack of economic recovery, China is also seeing problems. Inflation is pushing a seven-month high and the government is trying to shift the Chinese economy from being export dependent to domestically oriented.

So while the headline number looks nice, if the Chinese economy hits its target of 7.5% for the full year, it will still be the worst growth level in 23 years. Is that the economic recovery we should be celebrating—the worst level in decades?

Most of the media are printing headlines such as “Chinese Economy Accelerates,” which looks great. But the problem is that most of the boost the economy is getting is government-led. Exports are pulling the economy down, so the government is pumping even more money into the Chinese economy to keep it afloat.

Infrastructure spending is rising at a massive pace. Now, I do think that spending on infrastructure can help build a long-term economic recovery if it’s done correctly; this means fixing roads that actually need to be fixed. However, the problem is that the Chinese economy is growing even more dependent on spending in any capacity. We all know about the Chinese cities that were built and are now completely empty. This is taking the old saying about the government hiring people to dig ditches and fill them up again to absurd levels.

Officials know they need to shift the Chinese economy from this dependence onto a more sustainable path. The problem is that this will cause pain not only to the Chinese economy, but the economic recovery around the world.

As an American investor, don’t think you’re immune to what happens in the Chinese economy. Some of our biggest companies conduct a lot of business within the Chinese economy, including Caterpillar Inc. CAT.

Firms like Caterpillar need the global economic recovery to begin accelerating, since their products depend on growth. If the economic recovery falters, what happens to new projects and developments? They get delayed until the economic recovery takes hold, meaning the company’s growth is also put on hold.

The Chinese economy is extremely important for Caterpillar, not only for this quarter, but over the next decade. If the Chinese economy’s growth rate begins to slow, investors need to re-price their estimated revenue and earnings for firms like Caterpillar. Downward revisions are never a positive for a stock.

What I do know is that if we don’t see a global economic recovery begin to emerge over the next few months, stocks that have gone straight up recently will likely come back down to earth, as investors begin to realize that much of the growth was not based on strong fundamentals, but short-term government-led band-aid solutions.

This article What’s Really Behind China’s Economic Growth and Why It Won’t Last was originally published at Investment Contrarians