The mainstream view is that China can smoothly transition its economy from construction to consumption. This is a dangerous illusion.

China's rapid rise through the economic ranks was due to the twin drivers of infrastructure building and exports.

Stories abound on China's 'ghost cities'. The Chinese obsession with all things property has led to a possible credit bubble in the shadow banking system. The prospect of this bubble bursting is making cautious investors very worried.

And the anemic numbers on the Baltic Dry Index (which measures shipping rates) indicate the export business isn't as robust as the Chinese authorities would like.

One of the stimulus measures touted by Beijing is the push for more urbanisation. That means moving citizens from rural areas to soak up the excessive supply in existing urban areas and to create fresh demand to justify more development.

An Unstable and Unsustainable Model

The transition to consumption will take time. So the authorities have resorted to the tried and true practice of building more 'stuff'. This is an easy way to create the jobs needed to maintain social stability and retain their power base.

There is no question this formula has been successful in achieving this objective.

Over the past five years, the IMF estimates emerging economies (of which China is by far the largest) have accounted for three quarters of global growth. Little wonder the west is so keen for this 'growth' story to continue.

However, the economic platform China has built isn't a stable or sustainable model for the future. At some point (and some argue this has already happened) they'll reach saturation point - they won't need any more train lines, shopping centres, skyscrapers etc.

Nouriel Roubini recently observed (emphasis mine):

'China's leaders face plenty of other enormously complicated challenges, like managing the risks created by a shrinking labor force, the increasingly free flow of information within the country's borders, the degradation of its air and water, and the costs and complexities of providing for a rapidly ageing population. And given China's outsize importance ...its success and failures will be felt globally.'

When thinking about the problems facing China, few analysts discuss its ageing population.

The fact is demographics are destiny. The gradual retirement of millions of baby boomers in the West is destined to reshape economic growth.

China faces a similar demographic time bomb. According to China's Ministry of Education more than 13,600 schools closed in 2012. This is a result of the one child policy. Apparently the number of primary school students fell from 200 million to 145 million between 2011 and 2012. Remember, these school children are supposed to be the future taxpayers.

At the other end of the spectrum China has an impending social security crisis. The People's Daily newspaper published an article recently warning the number of elderly could rise from 194 million in 2012 to 300 million by 2025.

A diminishing future tax base to support a growing future pension base. Does that sound familiar?

According to the article, Beijing is toying with changes to the one-child policy and lifting the retirement ages from 55 to 60 for women and 60 to 65 for men.

As always when politicians tinker, there are consequences.

There will be the obvious backlash to the prospect of increasing the retirement age. This is the first hurdle to cross. Assuming they do this, the policy really only buys time but doesn't deliver a solution. The people are still in the system.

The other consequence is the impact on the rising level of unemployed university graduates. With older people staying in the workforce longer, this will only frustrate the employment prospects of the younger demographic.

The other thing is whether modern Chinese couples want to have more than one child or any children for that matter. Like their western counterparts, they too face the pressures of modern living. So the pitter patter of more Chinese feet isn't a given.

China is facing a demographic problem similar to the West, but it doesn't have the middle-class income to tap into. China's demographic problem is its citizens are growing older faster than they are growing wealthier.

China: Vulnerable and in Trouble

China built its success on cheap labour. Ironically it needs to fund its future from a shrinking pool of more highly paid younger workers paying higher taxes.

Transitioning to a consumption based economy is a great theory but in reality it's not easy with a rapidly ageing (and relatively poor) population.

Consider how much more difficult that situation would become if China experienced a hard landing from a property bubble bursting. Millions would hit the unemployment queues and take to the internet to vent their anger (similar to the Arab Spring). How do you tame 1.3 billion people? With great difficulty!

The bull in China is nothing to do with a raging market. It's everything to do with the highly massaged economic data that the gullible West accepts. The West accepts it because they don't want to think about the alternative.

No doubt China will become a much larger economic power. It could even surpass the US by the end of this decade.

However, no empire - Roman, British, US - has ever grown linearly. They all experience growing pains. China's State-managed economy has been on a tear for two decades without pausing for breath.

The imbalances (property and credit bubbles) embedded in the system from this rapid growth and a demographic time bomb make China vulnerable to the contracting forces in the West.

You know the damage caused by the Bull in a China shop. So make sure you get your valuables out of the shop before the rampage begins.

Vern Gowdie+
Editor, Gowdie Family Wealth

The Daily Reckoning Australia