I realise now that I misled you badly in the predictions I made at the start of the year about the important art events to look out for in 2007. I said that, following the big openings of Renoir at the National Gallery and Monet at the Royal Academy, we would all be reexamining impressionism. Silly me. With the year only a quarter old, it is already as clear as crystal that Renoir and Monet are mere bit players in the annual performance, and that the real drama unfolding around us is the rise, rise and rise again of Chinese art.

The other day, in Hong Kong, Sotheby’s put on sale a twee and ghastly painting by Xu Beihong of a smiling Chinese girl performing in a makeshift village theatre. The painter was one of the chief favourites of communist art, and the picture was produced to raise money for the fight against the invading Japanese. So it had tons of private national meaning for Chinese collectors. Five of them wanted it badly – really badly – and by the time they stopped bidding against each other the price had skipped to £4.1m, a world record for a Chinese painting. Add £500,000 for the Sotheby’s commission and you have a wicked amount of money to pay for an academic picture of no global worth, done in a style that was old-fashioned in 1839 – let alone 1939, when Xu Beihong painted it.

That is how it is with Chinese art today: as the prices soar, the values plummet. The situation is at its silliest at the contemporary end of the market, where a crop of repetitive Chinese painters trained at communist art schools to do the same thing over and over again have suddenly become the tigers of the auction rooms. In recent months, Zhang Xiaogang, a churner-out of a seemingly endless procession of blank Chinese faces, has outsold Damien Hirst and Jeff Koons. Last October, Saatchi bought a Zhang for £750,000. This record lasted a few weeks, until someone paid £1.1m for another. According to my back-of-the-envelope calculations, in a world where a pound gets you two dollars, the fiercely productive Zhang is probably the world’s most successful contemporary artist.

Obviously, the main reason for this ridiculous fiscal frenzy is the frightening amounts of surplus cash being generated by the Chinese economic miracle. Over and over again, history has proved that in times of plenty, the rich get plenty stupid and start going to auctions. Back in the 1980s, it was the ignorance of fabulously wealthy Japanese collectors who had developed a taste for bog-standard impressionism that fuelled the last great art bubble. This time around, it is the combative lust of Chinese zillionaires determined to outbid their fellow billionaires for picturesque reminders of the national transformation.

None of which would bother me much, or warrant much of our collective attention, were it not for the larger and darker ramifications of the situation. What worries me most here is not the stupid amount of money being thrown at low-level art, but the concomitant blurring of reality. Right now, China is involved in an enormous act of international hoodwinking. The entire country is being rebranded: Old China is desperately trying to pass itself off as New China. And this grand global illusion demands that the country be seen as wealthy, creative, successful, tolerant.

Art’s role in this illusion is to play along with it, and not to rock the boat. I have some grim personal experience of these matters. Five years ago, long before the Chinese Klondike began, I made a film in Beijing about contemporary art. None of the artists featured in this film were the slick political popsters who are now taking the auction rooms by storm. They were video-makers, performance artists, conceptualists, a feral creative generation using whatever lousy materials they could get their hands on to make serious and searing points about the ruthless knocking-down of the old neighbourhoods to make way for the grand pretence of the Beijing Olympics; the hounding out of town of the unsightly and the dispossessed; the resulting ruination of lives; the break-up of communities and families.

The artists I interviewed weren’t living in multi-million-pound gated complexes and driving around Beijing in Benzes, as the Zhang generation does. They were squatting in squalid apartments with nicotine-stained walls and no lights, where a single cup was shared between five of them. I was appalled by the conditions I found them living in. But also heartened by their refusal to suck up to the authorities and shut up.

One night, we found ourselves at a makeshift agitprop performance arranged in a bar. Various nervous audience members shuffled up to me and whispered that the secret police were there. We were being followed. And, when I tried to return to China to finish the film, I found I couldn’t. I was banned. I still am. My crime? Making a film that did not repeat the official Chinese story line.

Which is why I recommend The Real Thing, at Tate Liverpool, an edgy, gritty, hard-core selection of new Chinese art that confronts you with the reality of modern China, as witnessed by the truly important artists currently working there: the ones who see what’s going on, and don’t like it. Entering The Real Thing involves going into what appears to be a particularly bleak and oily factory, where huge bits of brutal machinery block your path. It’s unclear which particular contribution to the economic miracle is manufactured here – tractors? trainers? – but it is clear that nobody in their right mind would ever wish to work in such a place.

Yet the artist, Zhuang Hui, once did. The entire installation is a millimetre-perfect recreation of a real factory, right down to the battered bowls of soup that were slurped on site in a dirty clearing on the factory floor. What makes the whole work truly astonishing is that it has all been created out of painted polystyrene. It’s a grim illusion. About a grim illusion.

Next door, Wang Wei records the building of a brick wall inside a modern office building by a bunch of scruffy labourers. As soon as the wall is finished, they knock it down again. This glum photo cycle refers to the plight of poor labourers in Beijing who began saving bricks from the old neighbourhoods they were knocking down, thinking they could sell them back to the bosses for the new buildings going up. But modern Beijing is being built out of concrete and steel, not bricks. The redundant army of labourers found itself with a redundant heap of building materials. At a stroke, they were useless.

The Real Thing is full of these grim insights into what is really going on in the new China. But it isn’t all doom and gloom. A parallel artistic tendency, made just as obvious by the show, is a national appetite for particularly ruthless humour. Wang Peng, something of a hero in Chinese contemporary-art circles as the first Chinese performance artist, shows a video in which he is seen buying a padlock in a hardware store, then telling the shopkeeper to keep the key. The padlock is used to lock up visitors to Wang’s exhibition, who have no option but to watch the video of the only key being given away. Unable to get out, they push and batter the metal door with ever-increasing frenzy. It’s a fascinating piece of conceptual brutality in a fascinatingly brutal show about a fascinatingly brutal moment in the fascinatingly brutal history of a nation trying to hide its fascinating brutality.

On the way back to the station, I realised that this is also a show about Liverpool. In 2008, when China gets its Olympics, Liverpool becomes Europe’s Capital of Culture. To ready itself for this useless event, Merseyside is being brutalised as fiercely as Beijing. The stretch of the city that connects Tate Liverpool to Lime St station is currently as muddy, dirty, smelly, disjointed, slippery and ugly as a trench in the first world war. And it was raining.

The Real Thing is at Tate Liverpool until June 10

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