(FORTUNE Magazine) – Remember when everyone thought China was the world economy's Next Big Thing? It all seems so-o-o last quarter! The new wisdom on China is that its economy is ready to implode--turbocharged by cheap credit from mismanaged state-run banks, overinvested in money-losing factories and empty high-rises, bidding up prices around the world for everything from steel to Styrofoam. Listen to the chatter on Wall Street, and you'd think China was just another market fairy tale, soon to go the way of the Dutch tulip craze, Japan's financial bubble, and the U.S. tech wreck. Or worse, that China is an economic juggernaut hurtling out of control--and certain to drag the world down with it.

Global investors who clamored insatiably for China shares in December are turning up their noses at China IPOs. Business Week frets that China is "headed for a crisis." Barron's discerns a "great wall of worry" that the Middle Kingdom could plunge into recession. Alan Greenspan warns Congress that trouble in China would "create significant problems" for the U.S.

The handwringing is getting out of hand. Yes, China is overheating. But is it really headed for a meltdown? Jonathan Anderson, a UBS Securities economist in Hong Kong, draws a distinction between periods of overheating, when economies grow at rates that can't be sustained, and bubbles, when asset prices and productive capacity soar so far beyond underlying demand they pose significant risk of a sudden collapse. What's happening in China, he argues, is the former, not the latter. The most likely scenario, in his view, is that China will manage a soft landing, with real growth slowing from last year's torrid 11.5% to a more sustainable 7.5% in 2005.

A slowdown of that magnitude wouldn't be great news for multinationals like Motorola and General Motors that have poured billions into mainland factories in recent years, or for investment banks like Morgan Stanley and Goldman Sachs that have been salivating over the prospect of fat fees from managing Chinese IPOs. Nor would it bring cheer to Asian neighbors like Japan, where China sales accounted for half the growth in exports last year. Then again, it wouldn't be Armageddon--nothing near the carnage that followed the U.S. tech slump.

China sentiment turned from sweet to sour early this year when Beijing reported 2003 growth of 9.1%, well above the government's 8.5% target. Then, instead of easing as expected, growth in the first quarter surged to 9.7%. Pessimists are also vexed by a rise in fixed-asset investment, an aggregate measure of capital expenditures by government and business. In March such spending jumped 43% above last year.

To many, the data portend a repeat of the early 1990s, when runaway growth and rampant inflation led then--Prime Minister Zhu Rongji to rein in the economy with controls on lending by state-owned banks. The curbs worked, but at great cost. Property prices crashed, creditors defaulted, and tens of millions of Chinese lost their jobs. Morgan Stanley economist Andy Xie, among the most ardent bears, contends China is in an even bigger mess today. Banks have made more bad loans, he argues, while Zhu's successors have fewer policy weapons to bring them to heel. Xie warns of a "vast property bubble centered on Beijing and Shanghai," which he sees as the main driver of China's insatiable appetite for oil, steel, aluminum, and cement. When the bubble bursts this time, he predicts, losses will be "horrific."

But comparisons to China's last bubble are misleading. China's economy has been through radical changes since the 1990s and has acquired a broader, healthier base. WTO admission has opened new markets for exports. Beijing's push to dismantle state-owned enterprises and shift workers to the cities has created a huge demand for housing. China has a national highway network now, and eased restrictions on travel and consumer finance have made it possible for millions of middle-class citizens to contemplate buying their own car. Despite the breakneck growth, China isn't grappling with inflation. Notwithstanding spikes in prices for some commodities, the consumer price index remains under 3%--a far cry from the 1990s, when it shot to 22%.

Unlike Zhu, who waited too long to restrain speculative growth in the last expansion, China's current leaders are moving early. In late April they broadcast their concerns about overheating in a series of pointed remarks about reckless bank lending. At a conference on Hainan Island, President Hu Jintao condemned "excessive growth in fixed-asset investment" and "redundant construction." A week later the State Council announced that investors would be required to put up more of their own capital to fund new construction in problem sectors like property and steel. And bank regulators issued an across-the-board ban on new loans in the week before China's Golden Week holiday.

In theory, Beijing has abandoned price controls, centralized production targets, and other diktats used by Zhu to lance the last bubble. The problem is that China, stranded midway between central planning and a market economy, has yet to develop real capital markets to regulate credit in the absence of government bullying. And Beijing has found it difficult to discipline the myriad small banks controlled by provincial governments, where jawboning by faraway party leaders holds little sway against pressures to promote employment or the promise of a fat kickback.

For all the challenges, though, Beijing has improvised admirably. China's growth may be slowing, but for now, at least, this juggernaut remains right on track.

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