All eyes are turned to the Chinese stockmarket today to see if yesterday’s shudder becomes a slump: the 5 per cent fall in the Shanghai market is a reminder that the country’s recovery is not as solid as we would like.

The smaller Shenzhen Index fell 5.5 per cent as local investors took fright at reports of curbs on bank loans into the market and took profits.

The fall cut the rise this year from just under 90 per cent to 84 per cent in a day — that came after a 7 per cent rise in the past 10 days. Much of this has been powered by bank lending, but more than $US120 billion in so-called “hot money” came into the economy in the second quarter looking for profits: this helped boost the country’s reserves to a record $US2.13 trillion by June 30.

The fall sent tremors through other markets in the region, although Japan ignored them. Europe finished higher, but the US closed lower despite the Fed’s Beige Book of anecdotal economic reports reporting a slowing rate of fall in most of the central bank’s 12 reporting districts across the country.

That and a reasonably solid report on durable goods orders failed to move markets: some mixed quarterly reports didn’t help, it seems the worries about China were closer to the surface than it seemed.

Reuters’ closing market report said:

“US stocks fell on Wednesday as investors worried that China might be ready to hit the brakes on lending, a move that could curb demand and hinder the global economic recovery.

“Concerns about China hurt commodity prices and hit shares in the energy and raw materials sectors, while a steep drop in US durable goods orders in June fed fears of more economic weakness.”

Oil prices fell 6 per cent as US stocks rose sharply and other commodities were noticeably weaker: markets reports also said the China fears were a factor, especially among metals such as aluminium.

Australian eyes will now be watching China more closely — we are tied into China’s economy like few other countries. That was recognised by Reserve Bank Governor, Glenn Stevens, who finished his Tuesday speech in Sydney with this comment:

“If we are more integrated into China’s expansion, we will be similarly more exposed to the consequences of whatever might go wrong in that country. So our understanding of how the Chinese economy works, and of what risks may be accumulating there, will need continual work.”

Yesterday’s fall was the biggest in the 8 months the Chinese market has been rebounding on the back of the stimulus spending and unchecked bank lending: at one stage the Shanghai market was off 7.7 per cent.

The fall coincided with a comment in the Financial Times Lex column yesterday which remarked on the emergence of three bubbles in Asia: China, where the central bank has told banks to invest in the real economy, not shares. The FT also made hay over rising inflation in India where the market is up 84 per cent since March and the South Korean central bank expressing concern about rising asset prices.

It could have added the comments by RBA Governor Stevens on Australian housing and his warning of possible “over‑leverage and asset price deflation down the track.”

“While most of the world is still focused on stimulating growth, Asian policymakers are increasingly fretting about new bubbles,” Lex said. It had an immediate impact, newsagencies and market reports started talking about Asian bubbles within hours.

Going unnoticed was a repeat yesterday of the central bank’s warning to Chinese banks for the second time in a week. This time it was the deputy governor who backed up comments made by the Governor late last week.

“China would firmly stick to its moderately easy monetary policy and concrete the recovery momentum of the country’s economy, the vice governor of China’s central bank said on Wednesday.

“Despite an initial economy recovery resulted from the government’s stimulus efforts in the first half, the country still faced severe difficulties and challenges from both domestic and abroad.

“In the second half, the PBOC would use a set of monetary policy mix to coordinate a “reasonable” credit structure based on market rules, and to ensure more loans to major infrastructure construction and technology innovation,” Su said.

Chinese regulators have been warning for a month of the emerging dangers of too much lending into real estate, the market and away from the real economy. Crikey reported on the warnings last week.

They know they can’t raise interest rates or increase asset reserve ratios, like they did from 2006 to 2008 because that would probably cripple the recovery, but the unchecked lending in the first half is obviously worrying and could of itself further unbalance the recovery and stop it. So the authorities are jawboning.

So seeing the banks are state controlled, any move to limit lending in the second half will be the way it is done: by executive fiat, not regulatory moves.

Helping to dive yesterday’s selling in China was profit taking after several big stock floats in the past week in China and Hong Kong.

So the Fed’s news of a continuing slow improvement in the US economy followed Tuesday’s upturn in house prices for the first time in nearly three years in vanishing from the market’s thinking.

It will re-appear Friday, US time when the first update on second quarter economic growth is released. if the figure is too high for the market’s liking, China’s wobbles could be matched elsewhere.

That a rickety day on the Chinese sharemarkets, casino like as they seem at times, could rattle world markets, tells us again of the gradual erosion of America’s sheer dominance of all things business and economic around the world.

Meanwhile, Japan’s recovery is continuing, but don’t get too enthused, it could run out of puff unless there’s a surge in external demand for its myriad manufactured products.

Figures out this morning from the Japanese Government showed a 2.4 per cent rise in industrial production in June.

The preliminary reading was down on the revised 5.7 per cent rise in May, and also lower than market estimates and the initial forecast from companies given to the government of 3.1 per cent (revised down to 2.7 per cent).

China is buying more from Japan and with this and restocking and the re-opening of closed car and electronics factories, companies are building up output to restock customers.

The government’s stimulus spending is also chiming in, but the approaching change of government at the end of August could see a hiatus in spending as companies and consumers try to assess what the new government will do. Figures out this week showed retail sales falling in June from May and from May 2008.

Demand remains weak, but the government sees July and August output picking up from first estimates.

Even with the month-on-month gains in the past four months, output was down 23.4 per cent from June 2008. Which is better than the 29.5 per cent fall in May from May of last year.

The Bank of Japan has raised its outlook for the economy this month, citing rebounds in trade and production as reasons for saying “economic conditions have stopped worsening.”

Orders for Japanese cars and electronics are increasing because companies are restocking inventories slashed during the recession.

Exports rose 1.1 per cent in June from May, thanks to higher sales to China, and also to the US (from a very depressed level).

Economists believe the rise in exports, output will see the economy return to positive growth in the June quarter but they say the recovery will only hold if consumer demand replaces government spending and keeps demand growing. Business investment is expected to be sluggish for the next year or more as companies decide if they should cut production permanently and close factories.

It’s why the most important indicator in Japan at the moment is retail spending and the news this week wasn’t good, down for a 10th month in June.

Sales fell 3 per cent from June of last year, more than forecast by the market (it was looking for a fall of 2.5 per cent).

Department-store sales fell 8.8 per cent in June sales at convenience stores (a more import retailing idea in Japan than elsewhere) fell in June for the first time in 14 months, indicating that cash conscious consumers are really watching their spending.

The real kicker from the sales report was the surprise drop of 0.3 per cent in June from May, the first fall in four months and a further indicator of the fragility of consumer demand, thanks to job losses and contracting pay packets.

Forecasters had been looking for a rise of 0.4 per cent, which was way too optimistic. The had been looking for a boost from the Government’s stimulus package of more than $A150 for each resident in Japan, plus subsidies for buying fuel-efficient cars and low energy using appliances, such as whitegoods and TVs.