Image: A CRH high-speed train zips in a test run in Zaozhuang, in east China's Shandong province, Friday, Dec. 3, 2010. The Chinese passenger train hit a record speed of 302 miles per hour, 486 kilometers per hour, Friday during a test run of a yet-to-be opened link between Beijing and Shanghai, state media said.   © AP Photo

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China's economy will catch and then surge ahead of the U.S. economy by . . . 2015, 2020, 2025 or 2050.

The date is subject to debate, but the assumption is that in relatively short order the Chinese economy will be bigger than that of the United States, currently the world's largest. The argument makes basic sense to anyone familiar with compounding. China is growing its economy at 10% a year; the U.S. growth rate is closer to 3%. With that 10% growth rate compounding every year, at some point China catches the larger but slower-growing U.S. economy.

How long it takes really depends mostly on how you calculate the size of the Chinese economy. The CIA World Factbook notes that since China's currency is undervalued, the official exchange rate, which puts the size of the Chinese economy at $5.7 trillion at the end of 2010, isn't very accurate. Using purchasing power parity, which looks at how much a yuan actually buys in China, the CIA World Factbook puts the size of China's economy at $9.9 trillion. The size of the U.S. economy is $14.7 trillion.

Next year the gap will be $550 billion smaller, at current relative growth rates. It seems inevitable that China will match the size of the U.S. economy and then pass it by.

Image: Jim Jubak

Jim Jubak

Unless compounding really isn't at work in China's economy. The only thing that can derail these projections -- whatever year you think it will happen -- is massive misallocation of capital in China. If, instead of investing its growing wealth in projects that will increase the country's wealth in the future, China is pouring its annual "profits" into projects that will never pay off and should never have garnered a yuan of investment, then, maybe, China won't catch the United States. Or at least it will take much longer for the country to close the gap with the world's largest economy.

This is why the current scandal that shows massive graft in the construction of China's vaunted high-speed railway system is so fascinating and important. It gives investors a window -- albeit a window with a narrow view -- into how China allocates capital and how much capital China might be pouring down rat holes rather than into investments with positive returns.

And it gives us a way to guess how much longer it may take for China's economy to overtake that of the United States.

High-speed train wreck?

No doubt about it, the Chinese high-speed rail system is one of the wonders of the world. China began this year with 5,014 miles -- 8,069 kilometers -- of high-speed rail already in operation. In 2011, China will build out major connecting lines that will turn this into a true high-speed network. For example, by the end of December, a 664-mile (1,069-kilometer) line between Beijing and Wuhan will complete the north-south route between the Hong Kong border and Beijing. By the end of the year, the final links will be in place to connect Shanghai with Chengdu. Imagine a 1,250-mile trip through some of China's highest mountains and across some of its deepest river valleys at speeds of up to 180 mph (290 kph).

By the end of 2020, China plans to have built a high-speed rail system of 9,600 miles, or 15,450 kilometers.

A system like this doesn't come cheap. Over the next four years, China will spend an estimated $500 billion on high-speed rail.

You'd have to be completely naive about the way government spending works in Beijing or Washington to believe that so much government cash wouldn't draw a trainload of officials looking to grease their own pockets.

Investigations into that graft started with Ding Shumiao, a well-known businesswoman in the railway equipment industry, who in January 2011 was accused of taking $120 million in "fees" to arrange railway projects. From Ding, the investigation grew to include Liu Zhijun, who was the minister of railways until February and is a friend of Ding's. Zhang Shugang, the deputy chief engineer and director of the transportation bureau of the Ministry of Railways, is also under investigation. He was suspended from his post in February.

But what's interesting to me about what the investigation has revealed isn't the kickbacks and other forms of payoffs -- or even the amounts involved. $120 million is surely a lot of cash, but it's not enough to make the difference between a high-speed railway system that is economically viable and one that's a white elephant.

What the investigation also shows is that the decisions about the design of the system were driven at every step of the way by the desire to produce extra revenue for everyone involved, ranging from the state-owned companies that built the system to the real estate developer who would make a killing if the high-speed line extended to his or her city.

So, for example, over and over again, officials demanded that trains be able to achieve top speeds even if it meant spending more on rail beds, employing viaducts to speed construction (since elevating the track meant avoiding protests about appropriating land) and extending the network to as many towns as possible.

This has all resulted in a very big network with relatively high costs that includes some routes that will never pay off.