Since the late '90s I've read disconcerting rumors that Chinese prosperity is built on a foundation of dubious loans by undercapitalized banks. This is from the always interesting Ambrose Evans-Pritchard: If you are not keeping a close eye on the Chinese banking system, perhaps you should be. Bill McDonough, the ex-chief of New York Federal Reserve, let slip at a conference in Italy this week that China's rickety credit structure was the biggest single menace to the world economy. It was Mr McDonough, now an adviser to Lehman Brothers, who rescued the hedge fund Long Term Capital Management after it made an $80bn bad bet on Danish, Swedish and south European bonds in August 1998. He orchestrated three rate cuts, admitting afterwards that some $1,300bn in derivatives had threatened to topple like dominoes and "freeze" the global system. The trigger for this crisis was the Russian default, but the deeper roots lay in Asia's banks. ... Beijing admits that the banks are the "soft underbelly" of its booming economy, but says the system has been cleaned up after an estimated $400bn in bail-outs since 1998. Critics reply that fresh money has been wasted by Communist bosses meting out credit for political ends, digging the country into a deeper hole. Investment is running at 43pc of GDP, leaving an oversupply of factories and office blocks, like Japan in the 1980s, but with even less market discipline. Ernst & Young calculated the bad debts at more than $900bn in a report this year but was forced to recant by Beijing. Gordon Chang, author of The Coming Collapse of China, said the regime had embarked on a suicidal course, living from one day to the next from fear that 140m footloose urban migrants could turn violent. "China is just piling up more and more non-performing loans, and eventually it's going to come crashing down, because economically this doesn't make any sense," he said. "You can't blow up your balance sheet at 20pc to 25pc a year with a well-managed bank in a well-regulated society. How the devil can you do it in China? This is just ludicrous," he said. "Monday view: China's banks are the Achilles heel of the global boom" By Ambrose Evans- Pritchard Last Updated: 1:21am GMT 12/12/2006 http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2006/12/11/ccview11.xml If ex-NY Federal Reserve Bank President McDonough's fears materialize the consequences will be felt far beyond the Chinese border.