China bear Jim Chanos has stuck to his guns for five years now, He said again and again that real estate in China and the Chinese stock markets were both experiencing massively inflated asset bubbles and that they would come crashing back down to earth eventually.
It looks like Chanos was right. The Chinese stock market is down my more than a third in the the last three months, and Chinese commercial real estate is also swooning this year. Unfortunately, Chanos says its almost certain to get worse as the Chinese government is simply not capable of making the decisions required to solve the problem (ie, actually take its foot off the economic gas pedal).
The famous bear hedge fund manager was recently interviewed by the Huffington Post’s Lynn Parramore.
Jim Chanos became China bear in fall of 2009
In the interview, Chanos said first began to question the China economic miracle back in late 2009 when his team was looking at why the global mining business was actually doing well in the middle of a recession. “I knew intuitively it was because China was a vast source of demand for commodities, but I didn’t know how much until my real estate analysts put some numbers up on the white board. One of them said that as of the summer of 09, China had 5.6 billion square meters of real estate under development, both approved and pending. I said, wait a minute –you’ve got the decimal point wrong because 5.6 billion square meters is 60 billion square feet. And it can’t be. He looked at me and checked the numbers a few times and said, “It’s 5.6 billion square meters.”
Chanos went on to say that this was his “ah-ha” moment on China. He said given that half of that figure was office and mixed commercial space, ie, 30 billion square feet out of the 60 billion, divided by 1.25 billion people in China, then you’ve built a 5’ x 5’ office cubicle for every man, woman, and child in the country! He notes that the “latest number on that time series shows 10.6 billion meters currently under development.”
When Jim Chanos and his team finally crunched all the numbers, they determined that Chinese physical investments as a percentage of GDP was very close to 50%. He says: “What they were doing was just stunning. They were literally building a whole country in a matter of years.”
China economic model flawed
Chanos argues the Chinese economic model will inevitably produce diminishing returns. He offers an example: “The first international airport in a region is fantastic, the second one is questionable, and the third one is folly. In some of these cases we’re now at the point of folly on new projects. I keep pointing out to people that even if we take the Chinese numbers at face value — which pretty much no thinking person does anymore — their nominal GDP has gone from 15 percent in 2010 (ten real, 5 inflation) to 5 percent now (7 real, 2 deflation). So you’ve had, basically, even with their numbers, a 200 basis point, a 2 percent drop every year in GDP. That’s serious.”
He continues to say that an investment-driven model (China stopped being an export-driven model years ago) by its very nature begin to show diminishing returns on capital. That means the Chinese can keep propping up their GDP up by constructing another hydroelectric damn or building another highway, but if there is little to no actual need for these projects, the expenses add up quickly.
In closing, Chanos says he believes that just under half of the 50% of Chinese GDP spent on physical investments mentioned above, that is, 20-25% of the country’s total GDP, related to residential real estate. He says things are finally starting to slow down a bit now, so maybe 15-20 percent of GDP relates to residential real estate, but it’s a high number any way you look at it. For comparison purposes, at the top of the U.S. real estate boom in 2007, residential real estate represented around 6% of GDP. China is still at three times that percentage today.