Are you ready for a China implosion?

For years, as developed economies around the world have stagnated, investors have turned to emerging markets in general and China in particular for their better growth prospects. With huge populations and improving standards of living, companies around the world have seen China and its emerging-market peers as rich sources of new business that could make or break their success for years or even decades to come.

Yet many of those investors have counted on the sustainability of emerging-market growth rates over long periods of time. As that theory starts to run into the harsh reality of a global slowdown to which even China has proven susceptible, investors around the world need to examine their investing strategies closely to determine just how exposed they are to possible Chinese economic troubles down the road.

Soft, hard, or crash landing?
Few topics inspire greater disagreement than the state of China's economy. Because its economy is more opaque than those of the U.S. and certain other large countries, China invites widely differing views even among experts.

What we already know is that Chinese GDP growth is likely to drop this year to about 8%. Although that hardly seems like cause for concern, we also know that China's central bank has cut interest rates twice in the past month, strongly suggesting either that it knows further drops in growth are coming or that it fears that the slowdown the nation has already seen could have more extensive impacts in the future.

What's open to debate, though, is just how bad things could get. Some believe that the Chinese government's actions can succeed in providing a so-called soft landing for the slowdown, sustaining at least some economic growth going forward. But more pessimistic analysts point to the Chinese dependence on its banking system as well as a serious real-estate bubble, raising ugly parallels to the conditions that produced the worst recession in the U.S. since the Great Depression.

Protecting yourself
Already, Chinese investments have taken pretty big hits. Even Internet giant Baidu, which has long boasted lightning-fast growth rates, sits almost 30% below its levels from a year ago and has lost almost a quarter of its share price just since April amid concerns about its future. Unlike the U.S. market, Chinese stocks generally have gone nowhere in 2012, with the Shanghai Composite within a few percent of a three-year low.

In addition, other investments linked to China have also suffered. Obvious candidates include BHP Billiton (ASX: BHP), Rio Tinto (ASX: RIO) and Vale (NYSE: VALE), which for years prospered by meeting immense Chinese demand for raw materials but which now face the scary prospect of a slowdown that could wipe out much of their business.

What investors have underestimated, however, is the extent to which other sectors rely on Chinese growth. Consider:

• The rise in wealth of China has directly benefited the housing market, as foreign real-estate purchasers make up an increasingly important part of overall demand. If China implodes, then that demand could quickly go away, leaving the real estate market here in worse shape.
• Casino stocks once known for their Las Vegas riches now depend on Macau for their profits. A Chinese hard landing could hurt the entire East Asian region, in turn leaving gaming customers with less to gamble. Not great news for Crown (ASX: CWN) major shareholder James Packer. Even though most casino stocks are well off their highs, they're still arguably not pricing in the risk of a full economic collapse.

Stay on guard
Given the huge role that China now plays in the global economy, there's only so much that stock investors can do to protect themselves. What's most important, though, is simply to keep a close watch on the situation in China, always understanding that what you're seeing may just be the tip of a much larger hidden iceberg.

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