(I finished researching and wrote this article last weekend. It was not published by Seeking Alpha. For multiple reasons, I am not going to revise it and resubmit it for publication. I hope some of you find it useful and/or enjoyable.)
In the last year or so, there have been many written articles, video segments, et cetera, suggesting that the Chinese economy is headed for a big fall. These articles, segments and the like are often so filled with false and misleading information and flawed reasoning that it would be extremely time-consuming to address all of the errors within them. There are multiple reasons why there is now so much bad information regarding the upcoming fate of the Chinese economy. Some major reasons are as follows.
- More recently, more people have shorted certain Chinese and Chinese-related investments. They are concerned with influencing the price of these investments downward. They are not necessarily concerned with the integrity of the information used to do so.
- Some Americans simply want to push investment dollars toward the stocks of U.S.-based companies versus the stocks of China-based companies, even though the U.S.-based company stocks are often far pricier. They are not necessarily concerned with the integrity of the information used to do so.
- Due to (a) misdirected national pride, (b) an irrational dislike of any system with a “communist” label associated with it—versus a healthy skepticism of all like systems, and, on occasion, (c) racial prejudice, some Americans simply want it to be true that China is headed for a big fall soon. They are attempting to justify what they want to be true. This is different than seeking what is true.
- More and more in America, objective journalism, and the fact checking, et cetera, associated with it, has taken a backseat to what are, actually, advocacy pieces.
In a challenging communication environment like this, how do you get the information you need or want regarding the likely future of the Chinese economy to facilitate your investment decisions? Two good rules to follow are these.
1) Evaluate the source. The source should not be strongly motivated to mislead you in one direction or the other, and they should not have a track record of providing misleading information. Also, they should be well-qualified to write or speak regarding the specific matter.
2) Verify the accuracy of information.
Exercising these principles, I will address some questions regarding the future of the Chinese economy. I will begin in this article by addressing the China construction myth.
The China Construction Myth
The myth is that construction constitutes a massive portion of the Chinese economy, a far larger portion than is sustainable. Jim Chanos, president and founder of hedge fund Kynikos Associates, may be the greatest source of this myth.
In a February 10, 2011 segment on CNBC’s Squawk Box, Chanos claimed: “Construction as a percent of the Chinese economy in 2010…it’s 70%.” (Source, beginning at the 6:09 mark.) With a small amount of economic knowledge and common sense, it is obvious that this statement cannot possibly be true; yet neither of the Squawk Box moderators involved in the conversation questioned Chanos’ statement.
A simple “gee, Jim, that can’t be correct” would have sufficed.
Chanos made this same claim previously. The only difference is that, now, the percentage claimed is even higher.
Chanos isn’t the only source of absurd misinformation on this topic. Here is a website telling us that the “construction industry contributed 53.1 percent of (the) GDP of China in 2005”. In the very next sentence, the website tells us that “in 2004, (the) industrial sector comprised 52.9 percent of China's GDP”. Since construction is a sub-component of the industrial sector, the website is called EconomyWatch, and, per EconomyWatch, “EconomyWatch.com is the largest online economics community in the world”, the author and/or editor should have enough knowledge to not continue to publish this clearly false construction industry statistic.
A more extensive Internet search reveals that industry (with construction as a subcomponent) contributed 53.1% of China’s GDP in 2005.
The China Construction Reality
U.S. Central Intelligence Agency, The World Factbook, China, GDP – Composition by Sector, 2010 Estimates:
Agriculture — 9.6%
Industry — 46.8%
These percentages are consistent with the non-estimate percentages for the years prior to 2010. As previously mentioned, construction is a subcomponent of Industry. Also, Industry includes many other things beyond construction—including the vast majority of China’s exports. It is not vaguely possible for construction to be anywhere near 70% or 53.1% of China’s GDP.
Per Reuters on March 3, 2011: “After overtaking the US as the biggest construction market in 2010, China's construction sector will more than double in size to $2.5 trillion by 2020, accounting for a fifth of world construction, PwC said, citing a report it sponsored.” “The construction sector worldwide currently accounts for more than 11 percent of global GDP and the report predicts that it will account for 13.2 percent of world GDP by 2020.”
This indicates China’s construction sector was sized at less than $1.25 trillion in 2010. Per The World Factbook, China’s estimated 2010 GDP was $5.745 trillion. Via the International Monetary Fund and World Bank, a $5.7 trillion estimate is obtained. This indicates that China’s construction sector was less than 22% of China’s 2010 GDP.
In May 2010, international business research company Freedonia described Chinese construction as a “7.8 trillion Yuan…industry”. In May of 2010, the exchange rate was about 6.83 Yuan to one U.S. Dollar. Using this exchange rate, 7.8 trillion Yuan equals about $1.14 trillion. This indicates that China’s construction sector was about 20% of China’s 2010 GDP.
According to a December 2010 International Monetary Fund Working Paper entitled “Are House Prices Rising Too Fast in China?”, “real estate investment now accounts for…around 9 percent of (China’s) GDP”. Real estate is a sizable subcomponent of construction.
There are some good reasons why China’s percentage of GDP constituted by construction should be higher than that of the world as a whole.
- China is a developing nation. Developing nations need to build the infrastructure upon which they can become developed nations. One of the reasons for China’s greater GDP growth rates in comparison to other developing nations is its better infrastructure.
- China’s post-economic-crisis $586 billion stimulus package was, by far, mostly construction-oriented. This package significantly increased 2009 and 2010 construction spending.
- A lot of Chinese housing from the past is of very poor quality. Residents of China have a very strong bias toward new, versus existing, housing.
Adjusting downward to eliminate the affect of the stimulus package, China’s construction percentage of GDP appears to be about 18%, versus a world percentage of about 12%. Also, China is a developing nation and has a very strong bias toward new housing. When analysis is done and discussions take place involving whether China’s construction spending is too great, it should occur in this kind of a context. Anyone stating figures like 70% or 53.1% of GDP for China’s construction should be put on Ignore. You may not have a message board option which enables you to do this, but there is always the Ignore button in your head available for use.