Remember that Chinese asset bubble people were predicting for the last several months? Well, guess what? It never materialized. How could so many economists and investors have expected an asset bubble and while simultaneously expecting the highly risk-averse Chinese government to do nothing at all to stop it one from happening? Perhaps its stems from what seems to be a consistent underestimation of the ability and commitment of Chinese officials.

Now we face the opposite situation. More than a few people are beginning to fear a Chinese hard landing, or at least a very meaningful slowdown. They are betting on a hard landing in China confident that policymakers will mistakenly tighten too much. China it seems is either too hot or too cold but never just right.

Of course it is possible that Beijing hits the brakes too hard. After all, the Chinese policymaking apparatus is big and diverse and so there are many moving parts. There is a strong penchant for micro-management, or as they prefer to call it “fine tuning”.

And, as usual, there is a lot going on. Apart from the problems in the west, China is still in the midst of working out how to refocus the economy away from exports and heavy industry towards services and consumption – which is a long term process. Another longstanding policy goal has been to increase China’s energy efficiency and some of the ways of achieving this have recently been accelerated – such as closing down inefficient enterprises and adjusting power prices upwards for heavy industrial users. At the same time various forms of policy stimulus are in the process of being withdrawn. While last year’s surge in infrastructure investment will continue to underpin the economy, new project starts have been more difficult for over six months now, with state funding of fixed asset investment down sharply from its peak in January 2009 and slower momentum in fixed asset investment growth as well.

Most topically and most importantly for sentiment is the recent crackdown on China’s property market. It has been clear over the past couple of months that China had a rare consensus of opinion across all levels of society, from waiters, taxi drivers and office workers to government officials, that recent property price rises were out of hand. Viewed as a potentially destabilizing social issue, this grabbed the attention of high level government officials who are not normally involved in economic policymaking. This led to an immediate demand for results across the policymaking establishment, disregarding the fact that many policy measures take time to take effect. So in contrast to normal practice, where policies are rolled out in baby steps and carefully evaluated before moving to the next, there has been a period when it seemed like new policies were emerging every day. But now, with transactions down by 50-70% across a number of cities and prices tailing off, it will be long before “big picture” official statistics take a noticeable turn for the worse – particularly in the property sector. This will be more than enough to convince the high and mighty that “the medicine is working”.

It is also important to remember that China’s tightening has been going on for some time now and a number of key economic drivers have already “normalized” back to pre-crisis levels. For instance real loan growth accelerated to nearly 30% during 2009 but is now back to 19% – close to the pre-stimulus pace of 17% seen in 2008. Infrastructure spending growth jumped to 40% in 2009, and is now back to 20% – below the 2008 rate of 23%. So from a purely China-centric angle, the likelihood of a significant pause in tightening has risen sharply.

But so what? After all we are not talking about a free extension of liquidity that will lift all boats “to infinity and beyond”. We are just talking about a pause, while everyone gets their heads together and assesses the situation. And then won’t the economy just continue to sink?

Speaking to the “real” members of the economy, by which I mean companies and consumers, a slightly different picture emerges. In most cases, capex cycles are just beginning. While this is clear from speaking to the many companies we visited during an a recent (extended) trip, it can also be seen in broader economic statistics, where, for instance, the “construction and installation” component of fixed asset investment growth has been outpacing the “equipment purchase” component for the past few months. This ramp up should also provide a solid backdrop to the employment picture. Even if the outlook for Europe makes some of them cautious, most companies are still lean relative to the past few years. Consumers, meanwhile, are cash rich, making a decent living and still keen to upgrade living standards through new purchases. As long as the government does not engineer a “crisis of confidence” we think the economy will move forward.

This is not to say there won’t be some bumps along the way. Greece could still default. One or two other countries could default as well. Even before the Greek tragedy became a panic-level issue, Chinese policymakers were already very concerned. Now that the crackdown on the property market has already begun to see clear effects, we expect the level of concern they are showing to become significantly more market-friendly.

Markets are already factoring in a lot of tightening – for instance note that Chinese property stocks have underperformed the market by nearly 80% over the past 8 months. Over the course of the year we expect one or two modest hikes in interest rates, which are likely to be supported by equal and opposite stimulus-like measures, and should prove positive for the banks.

We believe that once it becomes clear that China does not intend to destroy demand for property altogether, and as long as Germany and France do not default as well, markets should respond fairly positively. We would expect to see them well above current levels by late summer.

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