Mumbai’s sudden ban on Chinese toys was attributed to some political strife surrounding Pakistan or as an aggressive protectionist move disguised as new safety guidelines. Regardless, it hits China as toy factories continue to close in Guangdong Provence at a rapid pace. Whether or not the toy ban could inflict further damage on China-Indian trade relations remains to be seen, but if in fact dealings deteriorate China could feel the economic pain.

India’s imports from China surged by 60% in 2006-07 to reach $17.4 billion from $10.9 billion in 2005-06, according to the Global Network of Exim Banks and Development Finance Institutions (G-NEXID). China is now India’s largest trading partner.

In turn, the past few years have seen China grab 60% of the Indian toy market – displacing domestic manufacturers.

The ban came just a day after the Chinese Ministry of Commerce posted statistics revealing that nearly 1,000 Chinese toy exporting companies in its Guangdong province had closed in 2008. The carnage was caused by a combination of unsafe toys being exported to the U.S. and a rise in raw materials.

Guangdong province cranks out approximately 70% of China’s toy products. According to Chinese customs statistics, 922 toy exporters in Guangdong went out of business in 2008, leaving 2,167 left from the 3,089 toy exporters which were operating in late 2007. Dongguan, the toy manufacturing center in Guangdong, was once hailed as the world’s “toy capital” with more than 4,000 toy factories and nearly 2,000 suppliers.

For investors, the message is loud and clear: China is in for a long slog.

The People’s Daily reported today that China’s Coordination Bureau under Ministry of Industry and Information Technology (MIIT) will replace “Made in China” with “Created in China.” The intent is show the world that China is no longer a copycat maker of disposable junk, but has risen to become a true manufacturing innovator.

Why should investors care?

Because China’s transition to a high-quality manufacturer comes at a time when the economy is softening — perhaps prolonging a slump in stocks, real estate and exports.

For example, the Wall Street Journal ran a story today that speculated China’s economy could be worse than stated by government agencies.

China’s economic policy has been to maintain a minimum growth rate of 8% for its GDP. Below 8% means that the Beijing is failing in the eyes of the world. Aside from the notion that China could inflate the GDP as its economy softens, one has to wonder how it can sustain 8% if it makes manufacturing more expensive by highlighting innovation over low cost.

The global recession has already hammered China’s exports — sending the economy into a nose dive. Now China wants to further increase the cost of its manufacturing?

As it stands, manufacturing in China has already been on the rise for the past few years — the higher margins stimulating its domestic economy.

The People’s Daily cited the United Nations Industrial Development Organization’s estimate that a total of 172 kinds of Chinese manufacturing products were high on the world lists in 2007. Specifically, 70% of toys, 50% of telephones, and more than one- third of color TVs were “Made in China.” The country’s manufacturing accounted for 11.44 percent of world’s total.

By moving to “Created in China,” the MIIT is promoting the integration of manufacturing and state-of-the-art computer systems, manufacturing and service, and the acceleration of innovation, according to the People’s Daily.

MIIT is proposing several steps to facilitate the transition from “Made in China” to “Created in China.”

Among them are guidelines for higher R&D spending, develop new brands that benefit from home-grown intellectual property, create entrepreneurial incubators that nurture creative products and businesses, and stimulate government purchases of original products as a form of recognition for innovation.

While this may pay off in the long term, the shift could present investors with a bigger challenge for finding near-term profits in China.

This from The Sovereign Society:

If you want to know how far this recession has stretched, look no further than China.

Up through this year’s Olympics, China seemed to be well on her way to becoming the next global economic kingpin. And with good reason.

China has had the fastest growing economy in the world for decades. The Chinese government has amassed trillions in reserves, while building up a trade surplus just last year of US$262.2 billion.

But lately, China’s fundamentals have been breaking down, one by one, like massive dominoes…

• Manufacturing in China just shrank by its largest margin EVER.
• China’s GDP growth for next year is projected to be around 7.5% – that’s down from an 11.5% pace not long ago.
• China recently adopted its own US$586 billion stimulus plan to try to jumpstart growth. (Notice: That’s more than twice China’s trade surplus of last year – it’s also nearly as much as the U.S. plans to spend on its US$700 Billion TARP bailout plan.)
• Housing prices are dropping in Shanghai, Shenzhen and Guangzhou.
• The central bank just slashed rates by the most in 11 years.

These dominoes are knocking down more than just China’s economy…

In fact, trouble in China spells disaster for the rest of the global economy. Specifically, a slowing Chinese economy is a dangerous situation for the United States, its surrounding Asian neighbors, over-exposed and over-indebted developed economies.

Global Manufacturing Clearinghouse Hits the Skids

You can trace all China’s problems back to their now broken export model. For years, China has played the middleman between Asia and the United States.

Their low-cost, cheap-labor production model dictated that they grab input products and other raw materials from nearby developing nations.

The Chinese then used those low-cost resources to build their goods and ship them off to the U.S. and other developed nations. China’s Asian neighbors depended on China to continue this cycle to fuel their own export-driven economies.

As a result of receding liquidity, U.S. consumers (and others) have a shrinking appetite for cheap goods, so they spend even less.

So, China is now losing its best customer, the U.S., thanks to the recession. It is also selling less to other developed nations of the world. This hurts all the emerging Asian economies that depend on China to buy their inputs. It’s a vicious cycle.

Emerging Market Currencies Will Be Hit the Hardest

In short, global capital flow has stopped dead in its tracks. And global demand is drying up. So it’s easy to see why emerging economies’ stocks and their currencies are being hit the hardest.

This is the worst possible environment for emerging economies because they depend on sustained global demand, more so than internal demand. When global capital flows dry up, these emerging economies struggle to make ends meet.

And any developed nations (and their currencies) that have exposure to these struggling emerging markets will ALSO suffer.

This includes several key European countries whose banks are over-exposed on loans to emerging markets and suffocating on massive liabilities. And this includes the euro and pound.

Just as China was vital to the boom, it is critical to the bust. And when that happens, a few currency investors who saw this coming will be in the best position to profit off this global realignment.

But there is no “One-Market” solution to play China’s bust!

Source: Why China Can’t Save the Global Economy

This is the beginning of an epic collapse of the Chinese economy… after this summer’s Olympic Games.

View the video here