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Is there really an overcapacity problem in China?
I have been reading about the overcapacity problem in China in financial blogs for quite a few months now. I have seen youtube videos about empty cities in China but there were no hard numbers on how big a problem this is until Jim Chanos announced some findings from his research on China to the media recently. He believes that the real estate bubble in China is unlike anything we have ever seen, like Dubai times 1000 or worse. One “fun fact” that he gave in an interview on CNBC was that there is currently 70 billion square feet of high rise buildings under construction in China and 30 billion of this is commercial (office space). To put it into perspective, this is equivalent to a 5 by 5 feet cubicle for every man, woman and child in China. Wow, if that is not overcapacity, I don’t know what is!
In case you have not heard of Jim Chanos, he is a billionaire hedge fund manager who specialises in short selling. Chanos built one of the largest fortunes on Wall Street by foreseeing the collapse of Enron and other high flying companies whose stories were too good to be true. In October 2000, Chanos started research into the valuation of Enron Corporation. He examined their use of mark to model (opposed to mark-to-market) accounting, which, in Chanos’ experience, results in management overstating earnings, as well as what appeared to be a worryingly low (6-7%) return on capital investment. Enron stock declined from $90 in August 2000 to a low of $1 near the end of 2001.
Jim Chanos only started his research on “China Inc” quite recently so his critics like Jim Rogers, another well-know American investor who now lives in Singapore have said “I find it interesting that people who couldn’t spell China 10 years ago are now experts on China.” Fair enough, perhaps we should hear from some real expert on China and I think Professor Yu Yongding should qualify. John Garnaut, The Age BusinessDay’s China columnist has this to say about Professor Yu “Some respected market economists say he has a better grasp of China’s macro-economy than anybody else, full stop“. Morningstar Analyst Ian Huntley also quoted Professor Yu’s work in his Forecast for 2010. Professor Yu’s research has shown that China’s growth has mainly been from the government’s investments in fixed assets and says this is NOT a sustainable growth pattern. When John Garnaut wrote an article in November 2009 that said worries about overcapacity in China is premature, Professor Yu’s response to him was “When a country has an investment rate over 50 per cent [of] GDP and rising, you say this country is not suffering from overcapacity! … are you serious?”
Jim Chanos concurs with Professor Yu that much of China’s miracle growth was the result of a fixed asset investment boom of staggering dimensions. When this bubble eventually pops, there will severe ramifications for certain industries globally, like steel and materials. Betting against China will not be easy because foreigners are restricted from investing in stocks listed inside China. Chanos has said he is searching for other ways to make his bets, including focusing on construction and infrastructure-related companies that sell cement, coal, steel and iron ore (look out Rio Tinto and BHP!)
Other conclusions that Jim Chanos has reached from his research are that the China miracle is blinding investors to the risk that the country is producing far too much. “The Chinese,” he warned in an interview in November with Politico.com, “are in danger of producing huge quantities of goods and products that they will be unable to sell.” He also believes that the Chinese banking system is loaded with bad debts. His views are very similar to what I have been thinking and writing about China in this blog.
Watch the two CNBC videos below (or read this New York Times article) to find out more about what this humble billionaire, Jim Chanos has to say about China. Their discussion on China starts at 4:45 min into the first video.
Note: Image courtesy of idea22
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