Sometimes it takes a year for the world’s media to catch up to a story. Late in 2008, China noticed that our economy had stopped. In turn, their export growth stopped, threatening that the Chinese too would suffer distress from the global recession.

So they announced a $585 billion direct stimulus program. They also forced their banks (which do exactly what the political leadership tells them) to push out another trillion dollars in new lending. In proportion to the size of their economy, that’s roughly as if we had done a stimulus of almost 40% of GDP: nearly $6 trillion, instead of the measly $787 bn we did. I’ll let that sink in for a moment before I go on.

Now the news headlines are catching up to the story (when they’re not focusing on search engine posturing, that is). China just surpassed North America to become the largest auto market in the world by unit volume. Sometime this year, China’s economy will pass Japan and become number 2 in the world. And Chinese exports soared in December.

Some in the press took this as a cheering sign that the recovery was finally taking hold in the US (terrific, our economic health is measured by how much of someone else’s manufactures we’re willing to buy). Of course, stimulus spending by the US benefits China to a significant degree, because they make the stuff we buy with stimulus dollars.

China is in the midst of what amounts to probably the biggest, fastest Keynesian stimulus ever attempted. Keynes basically believed that all demand is equal, and you could create useful economic activity by paying people even to do useless things. That’s exactly what China is doing.

Take a look at how China is doing this. Western commentators have been adamant that China should spend its stimulus money on social-welfare programs and national health insurance, which China doesn’t have. If they had done that, the beneficiaries of the programs would have just stepped up their savings. Instead the Chinese forced their bankers to lend money for new buildings and manufacturing facilities.

Does this make any sense? Well, there are still hundreds of millions of poor people in China. In theory you can build houses for them all and that would might make some economic sense. But instead, all the construction is happening in the cities, where it benefits people who are already in pretty good shape and creates price bubbles.

What about factories? China today does about 50% of the world’s manufacturing. So they could nearly double the amount of factory capacity they build and, as long as they keep their money underpriced, they can keep growing market share. And eventually, after the rest of the world gets sore that all of their own factories are suddenly outdated useless, that capital stock will be there to step up production for domestic consumption. So what they’re doing isn’t completely senseless.

So what about getting overextended? Can China repeal the iron rule that investments must pay off or the investors must go out of business? Well, in this case the investor is the state itself, which has more than $2 trillion in foreign exchange (aka, real claims against real assets owned by non-Chinese). As long as the state is willing and able to keep its banks in business no matter what happens, they can force them to keep creating industrial credits and quietly make up their losses at the end of each year.

That too would be the ultimate Keynesianism.

We’ll certainly find out soon enough where all this is going. But keep in mind that the Chinese have already had a lesson in this. Their economy was growing very robustly and sustainably early in the last decade. Somewhere about 2005, they started hitting problems. They had overheated, grown too much, and started seeing deterioration in the performance of loan portfolios. They still managed to keep up the growth, but inflation became a severe problem until the global recession started.

We’ll find out if things go differently this time. Watch oil, food and metals prices. Last month, I predicted we would see a $110 oil price this year. It might happen sooner rather than later.