This column originally appeared in CNBC on May 23, 2011
When I first visited Shanghai, the Pudong half of the city was mostly marshland. "Crazy!" was my reaction when told of plans to build skyscrapers there. Who would want to live there? A decade and a half later I live in Pudong, along with 8 million others.
Apple's (NASDAQ:AAPL) most profitable retail store in the world per square foot is located there, as are the China headquarters for IBM, Citigroup (NYSE:C) and DuPont (NYSE:DD), lured by tax breaks and cheaper rents.The Chinese government’s growth strategy has been to invest in highways, subways and bridges to previously difficult to reach locations to attract investment and spur development. Doing so has aided in reducing urban crowding and has improved efficiency.
In predicting China’s economic collapse famed short-seller Jim Chanos surprisingly does not understand how capital and infrastructure spending, rising incomes, and a lack of leverage are contributing to stable future growth.
Chanos argues that by taking up nearly half of China’s GDP that construction spending is too high. However, in contrast to Japan where many infrastructure projects lead to nowhere and do not spur sustainable development most infrastructure projects in China have a purpose. If towns remained empty forever or everything was bought highly leveraged, Chanos would be right that huge problems could emerge.
The reality is private enterprises eventually relocate to these development areas because of tax breaks, cheaper rents, and because many key government departments and state-owned enterprises take advantage of the developments to create new business centers.
Why is this development strategy needed? Far too many Chinese live in sub-human conditions because of land constraints and poverty. The country has an inhabitable area the size of America’s eastern seaboard yet five times the population.
It is common for families of 3-5 people to live in 350 square foot homes; the average house in America is 2,330 square feet according to the National Association of Home Builders. Many workers live eight people to a room. Workers are moving to urban areas in search of better pay. This year, for the first time, more than 50% of the country lives in urban areas, up from 30% just a decade ago. As the country continues to urbanize and incomes rise, people need more comfortable living conditions.
Chanos also makes the mistake of underestimating rising incomes. Per capita GDP more than tripled to $3,400 at the end of 2010 from $949 in 2000. The trend is continuing as foreign direct investment (FDI) is rising 25% a year, causing a fight for both white collar talent and manufacturing jobs.
Factory salaries at companies like Toyota (NYSE:TM) and Foxconn (OTCPK:FXCNY) are rising 20% year on year. The number of U.S. dollar millionaires has risen to nearly 1 million, when just dozens had that wealth two decades ago. In other words, rising incomes and urbanization are creating demand for any now empty units.
Finally, Chanos wrongly equates high real-estate prices with an impending bubble. What causes problems is not whether the average person can afford homes but whether people buying them are highly leveraged.
In China they are not. Even in the case of highly publicized development failures like Erdos, where a new district of the city developed to house government offices, businesses and up to one million new residents lies nearly empty despite the fact that many properties have been sold, any long-term damage to the economy is limited because property buyers were not leveraged.
Government restrictions limit leverage on the residential side as well as how many apartments one can buy. In Shanghai, for instance, one cannot even buy a third home anymore. Prices continue to rise in cities like Shanghai because instead of buying five units, wealthy consumers buy one luxury apartment. As a result, transactions and prices in the mid-market have effectively slowed while overall market prices have soared.
The government’s willingness to manage the situation has effectively squeezed speculation out of the market. The result? Real estate agencies are closing. Chanos sees this as a sign of problems ahead when in reality dropping prices and shuttering agencies is good because it signals government measures to keep the market under control and get more affordable housing to the people who need it are working.
It is easy to look at China’s construction boom, and the real-estate market there, and compare it to what has happened in the U.S., Dubai or Japan, but in reality the market is very different. Spending on infrastructure has a purpose, the trend is toward rising incomes and increased spending power, and property buyers are not exposed to anywhere near the level of risk that lead to collapses elsewhere.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.