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Jim Chanos Is Wrong: There Is No China Bubble

January 13, 2010
The famed short-seller Jim Chanos has been making waves lately by saying he thinks China is in a bubble and ready to collapse in 2010. He argues that easy credit has let real estate and stock market prices shoot upward. He also says the Chinese government is cooking the numbers to show 8% growth in gross domestic products, when actually China can't keep growing when the rest of the world has been hit so hard by the financial crisis.

Chanos called it right on Enron and Tyco before they collapsed. He is no lightweight observer of the economic scene. However, he is wrong about China. For once I agree with the famed investor Jim Rogers, who cofounded the Quantum Fund with George Soros. He says China is not in a bubble and adds that he finds "it interesting that people who couldn't spell China 10 years ago are now experts on China."

Betting against China in 2010 is a bad mistake for investors and companies alike. Here are three reasons why Chanos is wrong and Rogers is right about the strength of China's economy:

Chanos' first error is his belief that China's real estate sector soared in 2009 because of speculation triggered by a loosening of credit by China's banks. Lending in China doubled to $1.35 trillion in the first 11 months of 2009. Real estate prices rose sharply throughout the country and almost doubled in cities like Shenzhen. Chanos calls that a bubble--"Dubai times 1,000--or worse"--that could lead to fallout like the subprime mortgage mess in the U.S.

There are, however, fundamental differences between China's real estate and consumer finance markets and those of the U.S. and Dubai, which Chanos compares them to. First, when buying residential properties, consumers in China have to put down 30% before taking out a mortgage. For a second home, they have to put down 50%, no matter what their net worth. Therefore, China doesn't have the reckless consumer behavior that occurred in the U.S., where people with bad credit were taking out huge loans from Countrywide with no money down, or were buying 10 homes without deposits in the hope of flipping them in a few months. People who buy homes can afford it.

Also, mortgages are not being spliced up and packaged and securitized by the likes of Citigroup and Bank of America. Instead mortgages are held by the original lenders, the way they were in the U.S. before financial innovation and lack of regulation broke down the old rules.

The Chinese government also has no qualms about overseeing the market and has not been run by Ayn-Rand-loving free marketers like Alan Greenspan, who seemed to believe that no government intervention at all was best. The Chinese government is gravely concerned about social stability because of the widening gap between the rich and the poor. It is therefore limiting the sizes of new apartments and restricting the construction of stand-alone luxury villas. (Most people in China's urban areas live in high-rise apartment buildings. I myself live in a 60-story building.) The government is also forcing developers to build low-income housing. And to prevent flipping and excess speculation, it is heavily taxing sellers who unload their properties within two years of buying them.

The real estate business to be concerned about is commercial building. There has been way too much construction of large office towers, especially in Shanghai, which is gearing up for its World Expo this year. Too many gleaming skyscrapers sit empty of tenants. The glut of office space has already caused rental prices to drop in places like the Shanghai financial district, Pudong.

Too much leverage, not high prices, caused the problems with real estate in Dubai and the U.S. There just isn't that much leverage in China. So even if prices are too high, a drop of as much as 20% or 30% wouldn't cause anything like the tsunami that hit the American and Dubai markets.

The second way Chanos is wrong about China is that he, like most economists and Wall Street analysts, underestimates income there. I have recently been debating several Harvard economists who worry that incomes haven't risen as fast as GDP in China. They argue that it shows that too much of China's growth has been a matter of government investment in unsustainable infrastructure projects like bridges and highways, as happened earlier in Japan. They point out that Chinese consumers account for just a third of the economy in China, vs. two-thirds in the U.S. However, my firm, theChina Market Research Group, estimates that Chinese consumers will come to account for half of the economy within the next three to five years as the role of exports diminishes. (See my "Three Myths About Business in China.")

If anything, incomes are grossly underreported in China. A simple look at how accounting works will show why. Whereas in the U.S. individuals must report their income to the Internal Revenue Service every year, in China all individual tax is reported and paid for by companies, except for that of high earners. Many Chinese companies limit the tax they pay by reporting low salaries and then paying their employees higher amounts while accounting for the difference as business expenses like phone bills. The employees are happy because they make every bit as much as they were promised, and the companies are pleased to lower their tax exposure.

Also, many companies pay for housing and cars for their employees, a holdover from the old system of state-run businesses. Most Western economists don't count those expenses as income, but they should. Deceptive accounting of income is so widespread that the government has announced plans to tax some business expenses in state-run enterprises--the kinds of expenses that let executives pay taxes on earnings of $300 a month while living in multimillion-dollar homes and driving Mercedes.

The third thing Chanos gets wrong about China is the notion that the yuan is likely to appreciate. In the short term, it would be disastrous for China to let that happen, as I wrote in "Why Krugman Is Wrong About The Yuan." It would cause China's exports to plunge, swell the Chinese unemployment rolls by millions, and destabilize the financial system. In the long term, however, once the world's economy stabilizes, appreciation of the yuan might make sense. Getting exposure to Chinese assets now would benefit an investor when that time comes.

Chanos has an excellent track record in divining the future. However, part of his job as a short seller is to make money by causing markets to question good things. That can be useful for keeping companies honest and in check. But in this case he clearly doesn't understand the economic system he's talking about. China is not in imminent threat of collapse, and investors and companies are wise to stay involved with it, as Rogers argues.


Disclosure: none

This column originally appeared in Forbes.


Shaun Rein

http://www.cmrconsulting.com.cn

About the author:

Shaun Rein

Shaun Rein is the Founder and Managing Director of the China Market Research Group (CMR). He is a columnist for BusinessWeek's Asia Insight column. He has been widely published, written about and quoted in newspapers worldwide including Forbes, the Harvard Business Review, Dow Jones' MarketWatch, TheStreet.com, Investor's Business Daily, IHT, Finance Asia, the Wall Street Journal, and Barron's. He is regularly interviewed for National Public Radio's Marketplace.

Visit Shaun Rein's Website


Rating: 2.8/5 (10 votes)

Comments

LwC
LwC - 4 years ago
The author argues that "There are, however, fundamental differences…" when asserting that Chanos is wrong about the possible bubble state of the China economy.

Is this another way of saying "This time it's different"?

The author dismisses Chanos's opinion: "However, part of his job as a short seller is to make money by causing markets to question good things."

Well, I checked out the author's company's website. It appears to me that it is the author's job to generate fees for his company by selling China opportunities to foreign investors. Are we to believe that his opinion is less biased than Chanos's opinion?

I also note that the author is arguing against the appreciation of the Yuan (Renmenbi). One of his arguments is that appreciation "might make sense" once the world's economic system stabilizes. I note however that many of the arguments that are being made about the Yuan peg is that it is in fact a destabilizing force in the world economic system. How does one reconcile these diametrically opposed opinions? Should we just accept the author's self-proclaimed "China expert" status as the definitive point of view?

The author refers to a couple of reports written by himself to support his arguments. IMO it is a fallacy to assert his opinions as fact, and then argue that others' opinions are wrong based on his reliance on his own opinions as fact.

BTW I don't claim to know what's in China's economic future. However I am skeptical of claims that China is different and will somehow escape the economic cycles that have affected the rest of us for centuries.

yswolinsky
Yswolinsky - 4 years ago
Does anyone have data on chinas real estate such as increase in home prices versus inflation over the past several years, or the change in income to home prices etc?

That data would be the best starting point to judge whether China is in a bubble or not
Max7777
Max7777 premium member - 4 years ago
It is my understanding that Dubai banks also required 25% down on mortgages and that many were 100% cash purchases, but you only need a portion of the market to be too speculative to affect the entire market, and in these type of markets a 25% move can happen a lot faster in either direction whipping out the entire equity of some and affecting the entire real estate market.

I agree almost more with Chanos then with this author and see a lot of excess in China but I am still am long some commodity (LUK, POT) and oil stocks (PBR) based on the China story and even some consumer stocks in China itself (MR, EDU), and even the HAO index, but do not like the FXI because of the huge exposure (almost 50%) to Chinese Banks and therefore to Chinese real estate. I hear there are entire empty buildings there at huge valuations, so a bursting of the real estate bubble is very possible even if Jim Rogers is right in the long run, and I do think Rogers is right about China becoming the main world economic power in the 21st century.

If I could, I would short some of the excess in real estate against my China consumer longs. Does anyone know what would be the best vehicle to short china real estate?
LwC
LwC - 4 years ago
yswolinsky,

I'm not sure that the market data is available in a form that you or I are used to seeing it in. Also, AFIAK the housing markets in China are very local; in some places residential properties are reported to have doubled in the last year or so while in other areas price increases are comparatively moderate. I find it hard to believe that that kind of market action does not contain some component of speculative excess.

Regardless, many analysts and China watchers are skeptical of the economic and business reporting that comes out of China. IMO a report by John Makin, China: Bogus Boom?, is an interesting take on that point of view. It is available at http://www.aei.org/outlook/100061 .

At any rate, most analysts seem to agree that pretty much all bubbles share at least one characteristic: unbridled enthusiasm, or as Greenspan has famously called it, "irrational exuberance." Whether or not the author of the above article provides an example of wide spread irrational exuberance on China remains to be seen. Personally I am agnostic since I have no visibility and even if I did, there's nothing I can do about it one way or the other. The author could be right about the business environment, but Chanos could still make money with his selective bets.

BTW IMO some points that you made in a separate thread Google Reveals The Dangers of Investing in China are right on.

yswolinsky
Yswolinsky - 4 years ago
Here are some stats about China although I still hope to find a far more comprehensive study _http://www.businessinsider.com/the-chinese-real-estate-bubble-is-the-most-obvious-bubble-ever-2010-1#property-values-are-rising-dramatically-1
yswolinsky
Yswolinsky - 4 years ago
Thanks LWC If you are anyone else happen to have the following information or related information I would appreciate it, I am looking to write an articles on the topic of China examining the data without letting bias or emotion get involved:

Real Home Price index- (home price increases adjusted for inflation)

Average income and borrowing power

Home affordability in major cities

Net home equity extraction

Mortgage debt and home equity

combinded loan to value ratio

% mortgage loans w 100% financing

% loans with little or no documentation

rising home ownership rates

Securitization stats of banks

akclau
Akclau - 4 years ago
Chanos is right.

Property valuations must eventually be supported by the cash flow it generates which ultimately comes from supply and demand fundamental.

In 1st tier cities in China, with yield at below 3% (I am renting an apartment in Shanghai at a yield of about 2.3%) cash-flow does not justify the valuation of residential properties. You go around looking for apartments to buy or rent and you see that most of the new residential buildings are by large empty. In the mid to upper end of the market, you can tell with your eyes that vacancy rate must be like 20%+ being conservative. The demand and supply does not support the property valuation either.

Sure, actual income are often under-reported in China due to many cash benefit, subsidies and expense allowance. You can double the reported income and compare that to home prices, and then compare them to other "most expensive cities" such as Sydney, Vancouver, or the peak of the USA housing boom. Beijing/Shanghai/Shenzhen/Guangzhou in China blows them out of the water.

The simple fact that most young married couple now requires 3 family's money - both the husband and wife's parent chips in for the down payment, the couple pays the mortgage - to buy their first home is another clear sign that income does not support home prices, as well as a measure of the size of the bubble.

Yes, you need to put at least 20% to 30% money down to buy a house in China. You need to do that everywhere in the old days, and that did not stop housing bubbles occurring over and over again in different parts of the world in the past.
akclau
Akclau - 4 years ago
Oh... and despite what Greenspan claims - he is no "Ayn-Rand-loving free marketers like Alan Greenspan, who seemed to believe that no government intervention at all was best". He's a government official, who manipulates market via his central bank policies. All government manipulates market. Monetary and fiscal policies, despite their nice names, are simply a form of market manipulation that governments can do and we can't.

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