Why a downturn in China threatens to send the entire world into recession

The greater China is stitched into the world economy, the greater the dangers and opportunities for the rest of us

China is our new best friend. Wen Jiabao, the Chinese Prime Minister, is in town being fêted, his first visit in post to Europe. It is not hard to see why he is so welcome. China has been the world's fastest-growing economy for the past 25 years and building the economic links between the UK and China is an obvious priority. So the red carpet comes out and the rough edges of Britain's relationship post the Hong Kong takeover are duly smoothed.

China is our new best friend. Wen Jiabao, the Chinese Prime Minister, is in town being fêted, his first visit in post to Europe. It is not hard to see why he is so welcome. China has been the world's fastest-growing economy for the past 25 years and building the economic links between the UK and China is an obvious priority. So the red carpet comes out and the rough edges of Britain's relationship post the Hong Kong takeover are duly smoothed.

But to think of China as a good potential market for UK exports is to look through the wrong end of the telescope. Of course it is, and until recently the UK was the largest investor in China in the European Union - Germany has just caught up. But China's real importance is to the world economy, not just to ours.

For a generation the Chinese economy has grown at around 8 per cent a year and as a result is racing up the world league table.

It is either the world's second largest economy, after the US, or the fifth, after the UK, depending on whether you measure in real terms or at current exchange rates. This year it will pass Britain on the second measure, and it will pass Germany in another two or three years' time.

More important still is its impact on global growth. Last year China accounted for one-third of all the additional demand in the world economy, as much as the US, and of course vastly more than Continental Europe. (We don't have full figures yet but it looks as though Britain added more growth last year than the entire eurozone put together.) Already this is putting strains on the price of natural resources. Prices of "hard" commodities, such as iron ore, have soared, as have shipping rates. One very practical effect we can see every day when we fill up our cars. The oil price is at a 14-year high and the principal reason for that has been the additional demand from China.

On the other hand, the parallel surge in China's exports is holding down the price level of manufactured goods all around the world. Half the fridges imported into the US come from China and they have become the main foreign suppliers here. (I looked at one we bought a couple of years ago: sure enough, Made in China.) Chinese exports have given a downward push to the price of all white goods as other countries have struggled to match Chinese prices.

If China is pushing up the price of our petrol and pushing down the price of our fridges, it is also helping our universities balance their budgets. There are some 70,000 Chinese students in Britain, on the official count, more in fact than in the US. The unofficial tally is larger, so the actual total may be over 100,000. Since the Chinese, like all overseas non-EU students, pay full fees, they are in effect subsidising our own undergraduates. We should consider ourselves lucky to have them.

But a global economy that depends on just two countries, the US and China, to supply two-thirds of its growth is in an inherently dangerous position. It used to be said that if the US sneezes, Europe catches a cold. That holds true, but with a new dimension: if either the US or China were to sneeze, the whole of the world would catch a cold. The trouble is that there is a real possibility that China will indeed sneeze at some stage in the next 18 months.

Any visitor to China cannot but be awed by the visible signs of economic growth and prosperity. To see economic growth, ride in from either of the airports in Shanghai on a Monday and ride back on the Friday. I kid you not: the steel skeletons of the new tower blocks will be several stories higher. Crews are working 24 hours a day, seven days a week. It is the world's biggest building site. No wonder China is using 55 per cent of the world's supplies of cement. And that is just one city: the crescent extending south from Beijing to Shanghai and then round the coast to Guangdong is the greatest boom on earth.

The prosperity is equally evident in the shopping malls in Beijing and Shanghai: vast new palaces of consumerism are being built and in Shanghai at least they are crammed with shoppers.

People whose parents a generation ago would have been wearing identical blue overalls are now dressed in the swish kit of young urban professions everywhere in the world. It is as though this huge nation has embraced the new religion of consumerism with the same single-mindedness that it embraced communism, and it knows which one it prefers.

There are, unsurprisingly, flaws in this portrait. One is inequality. I gather than measured inequality between the richest and the poorest is now the highest in the world, higher than in Brazil. That is already causing great concern to the Chinese leadership and, to its credit, the ruling elite is trying to get the message out along the line that public services must be preserved. Inequality, however distressing - and you do catch glimpses of extreme poverty even in the booming cities - does not threaten immediately the world economy. The other flaw, over-investment, does.

Spend money on infrastructure and you can build beautiful airports, eight-lane ring roads and high-speed rail links. But you pile up debt and that debt has to be serviced.

So the Chinese cities look brilliant on the surface but they are overloaded with debt. Add in the debts of the state-owned enterprises and the banks, also state-owned, find that they are receiving no interest on nearly half their loans.

They would, in a full market economy, be bust. But since they are owned by the government, they cannot go under, or at least not yet. The Chinese government is gradually trying to improve the balance sheets of the banks, but if, in doing so, it cuts the rate at which they can make new loans, it risks pulling the plug on the waves of new investment.

In the past few months the economy has put on a spurt that makes the heady growth of recent years appear almost sedate. Instead of the growing at between 7 and 8 per cent a year, parts of China at least have been growing at 12 per cent, maybe more. Somehow the government has to try and slow things down. It is that growth we feel in the oil price. But it faces the universal problem of economic authorities the world over: how do you deflate a bubble slowly?

The greater the extent to which the Chinese economy is stitched into the world economy the greater both the dangers and the opportunities for the rest of us. The danger is self-evident: too sharp a slowdown in China would threaten another world recession. The opportunities lie in finding a way to link our own economy more closely to the Chinese shooting star.

The growth of China is the biggest economic story in the world at the moment. It is hugely in our self-interest to have good relations with any country that so dominates our economic future. But this is not just about selling goods or buying them, or about investment, or about commodity prices. It is about a stable world economy. So welcome, Mr Wen.