"They are trying to deleverage without blowing the whole thing up. The US couldn't contain Lehman contagion, but in China all contracts can be renegotiated, so it is very hard to have a domino effect. We'll see a slow deflating of the bubble," he said.
What is clear is that we are dealing with a credit expansion of unprecedented scale, equal in size to the US and Japanese banking systems combined. The outcome may matter more for the world than anything that the US Federal Reserve does over coming months under Janet Yellen - anything that's signalled in any case.
Societe Generale has defined its hard landing as a fall in Chinese growth to a trough of 2 per cent, with two quarters of contraction. This would cause a 30 per cent slide in Chinese equities, a 50 per cent crash in copper prices, and a drop in Brent crude to US$75. "Investors are still underestimating the risk. Chinese credit and, to a lesser extent, equity markets would be very vulnerable," said the bank.
Such an outcome - not their base case - would send a deflationary impulse through the global system. This would come on top of the delayed fallout from China's US$5 trillion investment in plant and fixed capital last year, matching the US and Europe together, and far too much for the world to absorb.
The effects of this on large parts of Latin America, Africa, the Middle East, and core Eurasia would hit before offsetting benefits accrued to consumers in the West. Such commodity shocks are "asymmetric" at first. Southern Europe would fall over the edge into deflation, pushing Italy, Portugal, and Spain deeper into a debt compound trap.
China did, of course, blink last month when the authorities stepped in to cover the US$500 million liabilities of the trust fund, "Credit Equals Gold No 1". It is the fifth trust rescue in opaque circumstances in recent weeks. Yet it would be hasty to conclude Xi is backing away from his Third Plenum vows to end the bad old ways.
The central bank (PBOC) is tightening methodically, allowing the benchmark 7-day repo rate to ratchet up by 200 basis points to 5.21 per cent over the past year. It drained a further US$50 billion from the system this week.
Its latest quarterly report has turned hawkish, even though producer prices are in steep deflation, and the M2 money supply is slowing. It complains "reliance on debt is still rising" and "hidden risks in the financial sphere require attention".
Zhiwei Zhang of Nomura says China has entered a "prolonged period of policy tightening" that will push up bank lending rates by as much as 90bp this quarter, leading to a chain of defaults.
The tell-tale signs are obvious in the central bank's handling of reverse repos and maturing bills. The yield on corporate AA one-year bonds has jumped 272 basis points to 7.15 per cent since June.
"We think the PBOC intends to raise the whole spectrum of interest rates to push deleveraging," he said.
This will be a rough ride. JP Morgan's Haibin Zhu says the shadow banking system alone has jumped from US$2.4 trillion to US$7.7 trillion since 2010, and is now 84 per cent of GDP. The total US subprime debacle was just US$1.2 trillion. He sees a rising risk of "systemic spillover". Two thirds of the US$2 trillion of wealth products must be rolled over every three months. A third of trust funds mature this year. "The liquidity stress could evolve into a full-blown credit crisis."
International Monetary Fund officials say privately that total credit in China has grown by almost 100 per cent of GDP to 230 per cent, once you include exotic instruments and off-shore dollar lending. The comparable jump in Japan over the five years before the Nikkei bubble burst was less than 50 per cent of GDP.
The transmission channel to the global banking system is through Hong Kong and Macau. Beijing's credit squeeze is causing a scramble for overseas dollar credit to plug the gap. Foreign currency loans to Chinese companies have jumped from US$270 billion to an estimated US$1.1 billion since 2009.
The Bank for International Settlements says dollar loans have been growing "very rapidly and may give rise to substantial financial stability risks", enough to send tremors across the world.
The BIS data shows British-based banks - a broad term, including branches of US and Mid-East outfits - hold a quarter of all cross-border bank exposure to China. German, Dutch, French and other European banks have cut their share from 32 per cent to 14 per cent as they retrench to shore up capital ratios at home.
Charlene Chu, Fitch's China veteran and now at Autonomous in Beijing, told the Telegraph last week these dollar debts were large enough to set off a fresh global crisis if mishandled. The world's central banks have no margin for error.
