Why Chanos Could Lose Big on China Bubble Bets

Includes: FXI, PGJ, TAO
by: EconMatters

Amid growing fears of a real estate bubble, Chinese officials moved to restrain bank lending and rein in inflation by raising its bank reserve requirements twice in one month. Global financial markets reacted with risk aversion driving up both the U.S. dollar and Treasuries because of concerns that the leading recovery growth engine of the world could be slowing.

High Price & High Vacancy

In Beijing, the amount of residential floor space sold in 2009 skyrocketed 82% from the year before. Bloomberg reported Beijing’s office vacancy rate of 22.4% in the third quarter of 2009. Those figures don’t include many new buildings about to open, such as the city’s tallest, the $966 million 74-story China World Tower 3.

In a separate Bloomberg report, an executive from a property advisory firm estimated that roughly 50% of Beijing’s commercial space is vacant today. Meanwhile, according to data from the National Bureau of Statistics, housing prices in China saw a 24% growth spike in 2009.

In January, property prices in 70 cities across China rose 9.5% year-on-year, the eighth consecutive year-on-year rise. Standard Chartered also noted in early February that at least seven cities saw land prices triple in 2009.

Dubai x 1,000?

What happened is that the liquidity bubble went towards the Chinese property market as developers with access to the $1.4 trillion in new loans last year built skyscrapers and luxury housing.

The surge in lending and strong house prices underscores the concern that the economy is at risk of overheating, reminiscent of the U.S. housing bubble. Famous short seller Jim Chanos characterized China as "Dubai times 1,000, or worse,” suggesting that Beijing is cooking its books, manipulating both financial and growth numbers, among other accounting gimmicks.

Bubble Call Premature

Most analysts, however, agree that whatever real estate downturn occurs in China, it won't equal the crisis experienced in the U.S. The issue with bubbles is the lack of an accepted scientific means to properly identify and measure. One way to look at it is to compare the China housing price inflation level with a known housing bubble – the U.S.

At the height of the U.S. housing boom in mid 2006, prices peaked as much as 90% higher than at the start of their six-year climb. Based on the data from the National Bureau of Statistics, the average home price in China had shot up roughly the same percentage in the period from 2004 to 2009.

Nevertheless, China’s pricing point started at a much lower level than in the U.S. So, the seemingly equal 90% appreciation does not necessarily translate into the same bubble story.

Koyo Ozeki, head of the Asian credit research group for PIMCO, made a strong case for China's real estate market in a recent research report that:

“Given China's potential growth, its real estate market has plenty of room for enlargement over the long term...”

Ozeki’s view is based on a comparison of the amount of credit that was extended to the Chinese property sector from 2003 to 2009 equaling 40% of China's gross domestic product. In the U.S., the figure was 80% from 2000 to 2007.

No U.S.-Style Bubble

Furthermore, the Chinese aren't exposed to the low-to-no-down-payment loans once popular in the U.S., as down payments in China average 40% to 60% of the sales price. In other words, the amount of buyer leverage is much lower in China as compared with the U.S., and is less likely to lead to a U.S.-style bubble.

In addition, the U.S. financial crisis was mostly a result of the securitization of mortgages, and the offloading from banks to the markets. This is not part of China’s market structure, which means the impact of a bursting Chinese real estate bubble would likely be much more muted.

Overblown By Short Sellers Agenda

Harvard University financial historian Niall Ferguson points out that:

"Excessively loose monetary policy causes asset bubbles and excessively loose monetary policy is what we have now, it's a little early to start pointing fingers and calling things 'bubbles,' however."

Essentially, The global fear perception of “a sharp new rise of asset prices = bubble” is stoked by the U.S. housing crisis, which ultimately led to the Great Depression, and is used to further Short Sellers' Agenda by the likes of James Chanos and others “talking their book” on short positions regarding Chinese investments.

Early Intervention Is Key

In the case of any bubble, the sooner the government takes measures, the less damage the bubble can cause to the economy. And Chinese authorities have already taken a series of measures including a nationwide property sales tax, and raising bank reserve requirements to slow the red-hot market.

The message coming out of Beijing right now is that policymakers are becoming more concerned about containing inflation and managing the risk of asset price bubbles. Some analysts also expect more monetary tightening from Beijing in the second quarter.

Long Term Challenges Abound

This is not to say all’s well in China. For instance, high property prices and dim career prospects for the young college graduates (a.k.a. 'ant tribe') will continue to pose a social economic challenge for Beijing. Economic stagnation would certainly exacerbate this imbalance.

But most of these challenges are long term in nature. If it took almost 20 years for the U.S. subprime mortgage bubble to pop, China conceivably should have plenty of time to still expand while implementing proper policies and measures to prevent a US style asset bubble collapse.

California & Greece Before China

So, Jim Chanos` view of China appears to have some premature conclusions based solely upon flawed analogies with the US real estate market, without taking into consideration the different cultural and market factors.

Meanwhile, in light of a Bloomberg report (h/t Mark Turok) indicating many “money-is-no-object” Chinese investors are traveling half way across the globe to buy up distressed properties in Los Angeles, California at an average price tag of $3 million, the following should serve as a timely advice:

The likelihood of California (and / or Greece) becoming a vassal state of China seems far more imminent than a bubble burst in the East. Place your shorts wisely.

"Reputation is a bubble which man bursts when he tries to blow it for himself." ~ Unknown

Disclosure: No Positions

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