Last week, I presented the case for why China is not in a property bubble. In doing so, I disagreed with Jim Chanos' view on the subject and presented my arguments, based on my recent visit, which included interviews with Chinese professionals operating over there and the statistics we have available to us. There have been a few strong reactions to the article. I followed up with Chanos, saying that I obviously disagreed with him on this issue but that I otherwise respected and admired his work. I asked if he wanted to discuss our differing views on China either on or off the record. He didn't and has since declined an invitation to express his views for this article. Chanos' argument -- and he's not alone in his thinking -- is that Chinese property prices are out of control, especially in the coastal cities. Almost by definition, his description of what's happening at the moment as a bubble implies a hard landing coming. He hopes to profit from that hard-landing by shorting the foreign companies directly benefiting from the current property boom. This would include names from cement (like Cemex ( CX - Get Report) and Lafarge), iron ore (like Vale ( VALE - Get Report), Rio Tinto ( RTP), and BHP-Billiton ( BHP), copper (like Southern Copper ( SCCO - Get Report), and Freeport McMoran ( FCX - Get Report), and oil companies (although Chanos hasn't disclosed any specific names he's shorted). It would also include foreign-based property companies with exposure to China, such as many Hong Kong-listed developers. My counter-view didn't dispute that Chinese property prices have been rising. Some have said prices in several cities doubled from 2003 to 2007 and they've doubled again since then. However, there are many factors which differ between what is going on in China now and what happened two years ago in the U.S. These differences, to my eyes, suggest that prices aren't as out of control as is often is suggested. Furthermore, the Chinese government has tremendous authority to intervene in the markets to ensure a soft landing. Its ability to do that will help the China growth story play on for many years to come.
Here are some of the disputing views I've heard since my article and my responses. 1. A bunch of men can't possibly correctly steer the second largest economy in the world. I understand the American bias here. China is now the second largest economy in the world. How can a small group of men in charge control such a vast and powerful force? Based on my recent two-week trip to China, I have a new sense of what drives the government. Starting with Deng Xiaoping, this government has taken great steps to embrace market forces to raise up the standard of living for Chinese society. Contrast its willingness to do that and the impact it's had on the country versus Russia's progress in the last 20 years. What I further understand is that the incentive the Chinese government has to keep the economy growing with as few social inequities as possible. The government doesn't not want to see the Chinese people grow unhappy and turn their anger towards it. This has led it to act with remarkable speed when it was necessary (such as the $500 billion stimulus package after the financial crisis) and I expect that will continue. 2. In coastal cities, average workers are spending 80% of their income on housing. This is unsustainable. When you're dealing with real estate, local numbers matter much more than aggregated national numbers. Every market is different. However, most of the criticism of China's property bubble has focused on the larger cities. I don't know who is saying average workers spend 80% of their income on housing, but this is not true. The average couple in a major Chinese city is bringing home 6,000 to 10,000 RMB each month. If you review the equivalent of Craigslist in China ( http://rent.021fang.com or http://sh.58.com ), you can see that there are many two-bedroom rentals available for 1,500 to 3,000 RMB monthly. Those are sustainable levels compared to most cities in the West. 3. New housing is geared towards high-end professionals and is beyond the means of the average worker, who cannot afford to live in the major cities. I did see new beautiful apartment buildings in major cities like Shanghai which are being rented out by large American companies for their expat executives to the tune of US $8,000 per month. So, yes, those types of housing exist but it doesn't follow that there is insufficient housing for average workers. From its rhetoric, the Chinese government appears to be sensitive to the potential problem of new housing that caters to only high-end workers. But it has direct authority to change this and, starting last year, it has already set policies in place to direct more development that is more reasonably priced. If it needs to, it can take further steps.
4. Commercial real estate being built is far outstripping demand. There's the equivalent of a five foot-by-five foot office cubicle being built for every man, woman, and child in China at the moment, in terms of new commercial real estate. This statistic implies that a 50,000-square foot shopping mall being built (assuming a shopping mall is included in this definition of commercial real estate) would have enough space for 2,000 Chinese to work in. Does that metric really mean anything? The point of this analogy is to scare people (Westerners) that there is over-supply. But does one mall, allowing people to go and walk around and shop, really equal cubicle space for 2,000 Chinese? It's an elegant conceit that sticks in people's minds but I believe it's an inaccurate conclusion. Yes, there are empty office buildings today in China. Yet, how will this play out? As a hard landing as Chanos believes or with price reductions that are subsequently absorbed as I do? 5. All bubbles are apparent after the fact and this has many bubble characteristics so it must be another bubble. When you consider there is nowhere near the leverage in China that there was in the U.S. residential market, as well as the fact that many medium- and large-sized property developers in China are well-capitalized, my money is on a property correction, not a crash. Because we are still living through the aftermath of a property bubble crash in the U.S., it's understandable to look at China through that lens. But we must recognize the differences. Many Chinese and Westerners living and working in China told me on my recent trip that they expected China to surpass the U.S. in GDP five years from now. They see China in the early stages of a long-term bull market. There will be ebbs and flows along the way, but the trend is definitely higher. I agree with that view. All this spells a soft landing in Chinese property, not a crash. There might be a 25% to 30% correction - one that might be even instituted by the Chinese government -- but this should help ensure moderately priced housing and a shake-out of more speculative developers that ultimately help the property market continue its march upwards.