Jim Chanos on China: Is Chinese Economic Growth Really Just a Massive Fraud?
December 9, 2010 24 Comments
This is an incredibly insightful analysis of the Chinese economic “miracle” by Jim Chanos, the renowned hedge fund manager. It’s a long one, so you might have to watch it in several sittings.
The level of meaningless construction spending and investment Mr. Chanos describes is mind-boggling and scary. At 28:50, he talks about there being 2.6 billion square meters of office space currently planned for construction. Mr. Chanos explains that this is equivalent to 30 billion square feet of office space, or a 5 foot by 5 foot cubicle for every man, woman and child in China. The question he asks is, when construction represents a staggering 60 percent of GDP growth, what happens when there is nothing left to build?
…When the Chinese bubble pops in the coming decade, we are going to be witnessing something spectacular indeed.
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China has presented a success to the world. They want to be thought of as a world power in every way. There are old line authoritarian communists in power and in order to keep the people occupied, they are doing what central planners always do, make works programs (or start a war). It appears the warring faction does not yet have the upper hand, so they continue to construct. There is a day of reckoning coming. If we were able to engage them on a different basis, perhaps one with more strength in our dollar, on a more fair trade basis it would be better for them and for us. Our house is not in order and their’s is even worse. We have compromised the value of our money, making it worth so much less so that big traders around the world are looking for other currencies with which to transact business. Will we see a collapse of the Chinese system due to the central planning errors of huge magnitude? If so, as it appears, there will be much attempt on the part of the U.S. and other major players to prop China up, rather than risk a major collapse. Soros has probably already shorted or will short the currency and make another billion or two. China will have to unload its paper holdings of U.S. debt, maybe quickly. That can destablize the market. So many possibilities and few of them good when it comes to the China situation, particularly when looking at the U.S. situation which will be so impacted by China’s economic fall. It won’t be just WalMart suffering.
Yeah – watching China collapse into a severe recession would be rough, but we may be a little more insulated from it then some other economies. China is a huge buyer of natural resources and their purchases have been propping up Australia, Brazil, Canada and others much more so then us. Economic difficulties in China would certainly impact us to the degree they hold a chunk of our debt, but it may not impact us as heavily as it would others.
Chanos in the above video compares the rise of China to the Soviet economic expansion of the late 1940′s and 1950′s, leading up to Sputnik. At the time, evidently everyone believed it was only a matter of time before they surpassed the U.S., but their centrally planned model led to gross misallocations of resources and ultimately brought their economy to the ground. I’m convinced something similar is happening in China on a very grand scale.
Haven’t watched the video yet. Also, hadn’t heard the construction quote. First thought though is that a 5-by-5 cubicle isn’t very big. And the 60% of GDP growth being construction everybody realizes that has to slow down.
So, I guess I agree that I think China will have to go through an adjustment when the finally pull the plug on the U.S. dollar and begin selling off their treasuries. Instead of importing our inflation (obviously apparent in their big city housing prices) there assets will begin to deflate. A big difference though will be the pain of this deflation. Most Chinese buy their homes with cash I think it was somewhere around 70+% of chinese people. So crashes in home prices won’t be as devestating to people as it was in this country where everybody has a mortgage. Second, while China’s financial sector has been growing debt pretty rapidly and I’m sure they’ll suffer from a down turn the Chinese people are net savers as is the government and Chinese companies. So while asset prices fall in China the Chinese will be in posistions to buy! Suddenly, the billion or so rural chinese who couldn’t afford homes, cars, nice clothes, etc will be able to afford all kinds of things. Yes, real estate will suffer, financials may dip for the short term, and their general market may dip the transistion will be short Chinese companies that are well posistioned for this will fair VERY strongly on the other side of this dip, particularly relative to the U.S..
Chanos as a famous stock-shorter is all about timing. I can’t afford to invest that way. I’m looking for strong Chinese stocks that will survive and become stronger from that dip. I will dollar cost average into them down (perhaps over the next year or two) and hopefully have a very strong posistion in Chinese stocks at China’s bottom!
I’m sure Chanos will make a killing on any chinese recession. I don’t have that kind of money to gamble with though and can’t afford the high cost and margin of those contracts. Doesn’t mean I can’t still invest long as I don’t think it’s going to be as huge as everybody is predicting.
One votes not only at the polls, but with one’s dollars. So… are your financial goals so important that you would suspend your convictions on “issues of right and wrong” and invest in a morally bankrupt regime? How do you reconcile your investment in this regime, with your professed refusal to compromise on right and wrong?
You’ve got to be kidding me right?!?!? I guess you’ve never bought anything at Wal-mart before. The entire American population spends more money on Chinese goods then we can imagine! There is no need for a reconciliation here. Why would you ask this? Are you trying to judge my investment strategy as being immoral? Or perhaps your trying to make an argument as to how people shouldn’t apply moral principles to their political and investment views? Which is it? Should morals completely be taken out of the public square or are you judging my investment strategy as being immoral and therefore not coinciding with my political views?
I guess to answer the question directly. You’d have to assume America isn’t already a morally bankrupt regime! You’d have to be able to say which sins are worse China vs. America. But my understanding of scripture is that sin is sin regardless anyways. So, I’m not sure on what basis you have the right to judge the degrees of sin? I assume as your asking this question though you have some basis for judging sins by degrees? Which sins are ok to you?
Second, a lot of my dollars are in the U.S. economy anyways as for speaking with my investment dollars they’re equally distributed across American Companies, European Companies, Chinese/Hong Kong Companies, and Commodities. If I can only invest money where their is NO SIN then where should I invest? What is the prefect company and the perfect sin free country in which you invest?
Third, generally speaking my Chinese stocks are traded on the Hong Kong exchange (i.e. Hong Kong operating differently then mainland China), one of my favorite being HKE.0345. This is an investment in the Chinese consumer not the Chinese government and not financials. Indeed the Chinese government probably holds shares of these companies, but they also own shares of U.S. countries and own U.S. debt.. So, I can’t invest in anything associated with China or America (because China owns so much of our debt).
Fourth, this is completely different! Political vote and financial investment are so completely DIFFERENT. One is product/service and the other is ideology! Sure ideology influences product and service but people are free to make their own choices about product and service as to what purchases they make and how they use them. For example, “Guns don’t kill people, people kill people.” However, I do vote my conscious with my dollar and my vote.
As for doing what is right when it comes to issues of investing I try to choose investment options that are located where the best Macro environment exists for their success whether that is geographic in region or industry in positioning. Like in the parable of the talents I don’t hide my resources in the ground but seek out areas where they have the best possibility to do good. Once I find those areas (I don’t see how a geographic area or an industry can be evil) It’s like saying a rock or tree is evil. The best location or position being chosen then leaves a choice of companies. I look for companies being managed in the best possible financial way consistent with moral principles, no-to-low debt, quality products, strong leadership/management, healthy financial indicators being a few aspects of my analysis.
As you see my investment philosophy and analysis are perfectly in line with my not compromising on my morals. I’d never invest in Chinese government treasuries (if I could), I’d never invest in U.S. treasuries (except to short them now a days), I wouldn’t invest in GM, Enron, or Goldman Sacs.
I would invest in company like Samuel Adams (serving the American Consumer), I would invest in my own development (I’m a sinner living in America), I would invest in Gold Mining stocks, and I would invest in companies serving the Chinese consumer.
Why would you ask this?
The question was concerning tax cut/economic legislation. Or, in other words, economic activity; is compromise on economic goals acceptable. You expressed the stand with no room for compromise concerning one economic activity (legislation) but appear to have room for allowable wrongs (a compromise) in other activities (investment strategies).
As to the rest it seems to be a debate between your two assumptions: “judge my investment strategy as being immoral” and “people shouldn’t apply moral principles to their political and investment views”
Neither of these assumptions addresses my question. And I don’t necessarily disagree with your conclusions out right.
I am curious as to the distinction you make between investing in a communist regime, and not accepting any compromise what-so-ever, based on moral grounds, on economic legislation here in America. No accusations are being thrown. Just wondering.
You raise some interesting points, FT. Chanos actually addresses most of them pretty spot on in the above.
To your point about home price collapses, he actually said this is one of the biggest threats to their economy. Evidently, most of the wealthy and semi-wealthy in China invest their life savings in houses. If the housing markets collapse, they will be stuck with a illiquid assets. Regardless of how they financed them, in a bad market, they won’t be able to get their savings out. Couple this with the fact that the population is aging quickly and there could be a lot of people who get quickly into trouble.
To your point on savings, Chanos mentions the above on savings being directed into a poor asset classes (homes, condos, etc.) that will be difficult to liquidate in a downturn. I would also point out that if their financial sector grows debt quickly, then there have to be borrowers on the other side who will be in trouble when they cannot repay their loans. Chanos also makes some interesting points about what he describes as massive unfunded liabilities of the government that are offset against their foreign reserves, rendering those less useful then would otherwise be the case. in a sell-off of treasuries, those reserves would inevitably lose significant value regardless.
The way I’m starting to think it will play out is that new construction will start to dry up, probably sometime in the next several years. Demand will simply dry up, as they have vastly overbuilt. Prices will collapse in the real estate markets and people’s savings will be greatly reduced. Unemployment will quickly rise. The banking system will come under immense pressure due to construction loans not being paid back and the collateral being poorly valued and illiquid. The government will bail it out and try to prop up prices, etc. (similar to the US). But the economy will contract and stagnate, as it did in Japan and as it is doing in the US. And I’ll bet there are riots and that it is politically destabilizing. I’m not thinking it will be outright collapse, but I won’t be suprised if it starts to get a little ugly.
I don’t think they’ll come back nearly as strong, b/c demographic concerns will begin to weigh on them – higher health care costs, few young workers to tax, etc.
I think India is the country to watch. I think China’s foolishness has taken our eye off the ball. India is better demographically and politically (though not perfect).
Ah yes, but Chanos hasn’t mentioned the elephant in the room – the one trillion US$ in Treasury Bonds China holds. The deal is that the US Govt keeps printing money on the back of these bonds, floods the market with fresh cash which is (for the greater part) then used to buy Chinese goods. The cycle then begins again. Once that cycle is disturbed, China’s contract economy will collapse and they will very quickly need to jump start a domestic consumer economy to take its place.
If they are forced to do this, they will dump treasury bonds at the same time, thus precipitating a soveriegn debt crisis. This will result in both countries facing a political crisis – it remains to be seen which system could survive the resultant severe stagflation.
So who is going to blink first?
This is the foremost point that surfaced in my mind, also. With China being a major holder of our indebtedness, the symbiotic relationship may be a major factor in their economic planning.
I would not sell short the Chinese propensity to look at the future in the long run. The West is renowned for our shortsighted approach to economic and political growth, while the Asians take the opposite track.
I think China blinks first. They still have very low per capita income and would face the prospects of 10s of millions of people living with reduced wages or being forced out of work.
Having them dump our debt would indeed be dangerous, but you can see our central bank has no qualms about buying it back up. (Don’t get me wrong- that wouldn’t work in the long-term, but it may hold things together for the short term). And with some political resolve precipitated by a debt crisis, we would could make major headway on Social Security and MediCare, the two biggest culprits in our enormous deficits by making them means-tested, moving up the retirement age, etc. And for all of our ills, we still have the most creative and resilient economy on the planet.
I think a severe Chinese recession would be damaging to us and our bond and stock markets, but not nearly as damaging as it would be to other economies that are more directly dependent on Chinese purchases of commodities (Brazil, Australia, Canada, etc.). We may actually be least impacted by their struggles, relative to other major economies.
In the end, I’m not afraid of China, until they loosen up their political regime.
I think they have a political system that is pushing them towards economic failure. They have created an environment where regional governors are held to unbelievable economic growth targets, and they achieve this on the backs of massive credit expansion and artificial currency suppression (the buying up of foreign currencies through the issuance of Yuan).
I think the struggles are already starting to hit them. Inflation jumped to over 5% in November year-over-year, I just read and has been ticking up by almost a percentage point a month for the past 3 months. Wages are rising rapidly in major cities and there are actually labor shortages in several key areas of the country.
China is instituting price controls, increasing bank reserve requirements, etc. but they are not stopping the supression of their currency. In order to truly stop this rise in inflation, they would have to take extraordinary means to clamp down on their money supply, which would severely damage their economic growth rates for a period of time.
I think their political regime has been blinded by their success. They are careening towards a rather magnificent economic adjustment, I’m afraid.
I suppose I had better comment on the main thrust of the argument, that there is a property bubble. Well, yes there is – but it won’t burst until credit dries up, and since the Yuan is not freely convertible it is a simple political decision not to allow this to happen. They will tackle the problem with wage inflation, growth in money supply and some minor anti-speculation measures. Things will only get knocked out of kilter if something major happens to the balance of trade – then my comments above refer.
I actually disagree here EKW. I think property bubbles will top of their own accord. It gets to a point where there are simply too many properties and no more willing buyers- it’s simple supply and demand. At some point, the artificially high prices will have caused them to build too much.
I agree they may tackle the problem through increasing the money supply, but it won’t change the economic reality that there are too many office buildings, factories, condos, houses, etc. relative to the population and relative to demand. To continue to perpetuate this would be absolute madness and it will start to become obvious to people. Furthermore, inflation is no panacea. It is politically destabilizing.
I think China will be on the losing end of the stick. We will go on- I have every confidence. We have high per capita income, a very educated workforce, relatively low poverty rates, etc. We definitely need to get our fiscal house in order, but we can do that. I think China is going to be the longer term loser.
I accept your argument Stephen, it’s one possible scenario – supply and demand certainly has a major part to play. The thing that gets me is the incredible way in which property is used in big Chinese cities. Much of it is not made available to house people, but is left empty to be sold on like black tulips. The Chinese don’t like to buy second hand, so keeping them empty helps keep the price up. So long as there are willing buyers, the property glut keeps growing whilst the people who make iPads continue to live in dormitories.
The willing buyers are the new rich of which there are millions, all seeking to get on the bandwagon. The new rich by the way are mostly party cadres who were able to use their positions on the boards of State Owned Enterprises to do management buyouts with company cash – or cadre sons recently returned from Harvard with a business plan and guarranteed contracts from the same SOE’s.
So when does the music stop? sure demand is not infinite, but it can continue long after factories stop making money – due to widespread Ponzi schemes. The collapse actually comes with a loss of confidence. The Chinese are going the opposite way at the moment – they think they are invincible. However, the killer for them will be the onset of protectionism in global markets – such a scenario is likely if more extremist personalities get into office in Washington.
There is also much talk about corruption leading to instability. Mark my words – corruption reinforces control. You only need to look at Africa to see that.
Very true on corruption reinforcing control. I still think it is ultimately the “control” that is killing them.
I guess my biggest beef is with the media, in terms of their portrayal of China. It seems whenever you read a media account of inflation in China or a property bubble, they always quickly talk about how the Chinese government has the tools at its disposal to pop the bubble or moderate it in some way- as though this were so easy. There seems to be an latent assumption that because the Chinese government controls so many levers within their economy, that they have overcome the volatility caused by the business cycle and can deftly manage any crisis.
I reject that assumption on its face. Economies are incredibly complex systems and I really believe when you grab control of significant elements within the economy, you create false economic signals that cause significant misappropriation of resources. My point here being the property bubbles. The Chinese government has much more control over credit flows in their country then we do in ours and they use it to drive growth.
Cheap money is propping up real estate prices and causing China’s vaunted “savers” to direct capital into empty buildings, houses, condos, etc. They are driving capital, commodities, labor, etc. into building empty buildings. It’s really crazy, if you step back and think about it.
Empty property as a “store of value” is going to look quite foolish for the Chinese pretty soon, I believe. Property is not overly liquid; it takes rather than provides annual cash flow (maintenance, etc.); it’s value over the long-haul ultimately rests in its usefulness. A near-term property bubble might mean holding an empty property is meaningful, but over the long-haul, that will certainly not be the case.
Again, with most savings either directed into property or being held in banking deposits, I could see that evaporating for the Chinese pretty quick in a recession. Property values will decline quickly – and the illiquidity of the property will mean people can’t “withdraw” their funds. Banking loans secured by property will become impaired, meaning banks will struggle to pay their depositors.
I could envision classic banking runs being a key element of any major Chinese economic crisis. The “savings” will all have been paper savings that could become significantly reduced in a major recession. Inflation will be the only “answer,” but it’s an ugly one.
Anyway – who knows in the end. But this is where I have my bet. I just don’t believe they can keep this game going for very much longer without a major correction.
“higher per capita income, a very educated workforce, relatively low poverty rates”
That of course is a very western argument. Asian cultural norms ensure that people with money are for the most part admired and not despised, so long as there is some trickle down. Since class distinctions were wiped out in China during the Cultural Revolution it will take time to build them back up again, and the noveau riche are doing just that. The migrant laborers at the bottom of the ladder are happy because they can send money back home, whilst the smartest can step up the ladder through entrepreneurship and, well, criminal activity.
The big Chinese cities are sort of like what New York or Baltimore was in 1890 with the new arrivals being dispised by the old residents, but tolerated for their utility in providing cheap labor. The greedy magnates are there too, corrupting local governments, breaking the rules and creating monopolies. They aren’t ready to quit yet.
“Empty property as a “store of value” is going to look quite foolish for the Chinese pretty soon, I believe”
Agree – but greed is such an overpowering force. What we are debating I suppose is “what will be the trigger for a collapse in values?”
A policy shift towards US Protectionism is certainly one; a war on the Korean Peninsula is another; but I do not see demand peaking domestically anytime soon – they are only getting started. A radical policy shift by the Chinese Government is also very unlikely because of the laborious way their Politburo works. So I think this could go on for another couple of years until there is a major geo-political upset (or unless one intervenes).
Thanks for dropping back by, EKW. That is where I think we’ll have to agree to disagree. I really believe the collapse in values for China will come more from within than from a major external force. Granted, they could go on for another few years- I’ll give you that. But I think we’ll see the end of this during this decade. I just really don’t think it’s sustainable, no matter what the Chinese government may try to do to keep it sustainable.
Actually I think we are coming closer to a compromise position. I agree something will give within the next few years. Getting the call (or should I say put) correct will be the hard part. As for external or internal, I agree it could be either. I just said geopolitical – that could include a major internal upset.
What would bring such an upset on is still a matter of speculation, but there’s more at play than the demand curve, or pretend central planning.
Understood. And I’ll agree, there are a lot of factors at play. I just strongly believe it will be the demand curve and pretent central planning that will be their undoing.
Thanks again for dropping by! Enjoyed the discussion.
To say we are enjoying this enlightening discussion is an understatement.
But a discourse on sins would not be complete if one did not consider, is there any nation state today righteous? No, not one. So since we are not to evaluate degrees of sin, which presupposes we have the clarity and insight of God to do so, then we are left with the conclusion all have erred and fallen short of the glory of God. We would advance that since more was given to us, more is expected of us, by men and by God.
China is a great concern. The U.S. is a great concern. Ireland is a concern, as are so many other nation states today. They spend what they do not have, then a day of reckoning comes. They offer 13 months of retirement for 12 months of work, they offer lucrative packages to government workers while the private sector is being squeezed more and more to pay for them. This can be sustained for a short time and then Greece, UK, Ireland, Iceland, (and you can just about insert most nation states here), face calamity.
There may not be a solution for the U.S. We may have gone too far. We do not wish to conclude this, however, and would like to see great effort made from our Congressman and our Senators (with all of whom we are in close e-mail and telephone conversation) to what all that can be done to prevent a collapse here.
Keep up the great discussion all! We are learning so much and it is definitely illuminating and entertaining (and sobering!)
Thanks for your spirited commentary, Southern Patriots. Our fiscal position in the United States is truly precarious at the moment- but it is not unsolvable. It will just take incredible political will. Glad you are in contact with your Congressmen. I’ve been in contact with mine at the ballot box.
I am sure Ireland is pleased with itself for being compared alongside China and the USA when its population is half the size of New York City (and using that comparison, some people are probably being counted twice
)
Spending what has not earned has always been part of the capitalist system, and that is how the banks make their money – lending out more than they can pay back to depositors at any given time.
The system works best when the money borrowed is used to increase consumer demand through the creation of jobs – so long as the growth is incremental.
Unfortunately property and warrant speculators realise that they can borrow 90% or 100% of the cost of property/share purchases and then gain exponentially from rapid appreciation. Greed ensures that lots more will jump on the bandwagon until the appreciation becomes unsustainable, then the whole thing falls down like a pack of cards. Thats were we are now.
Why did no one stand up and say stop? easy, because most political and business leaders had their noses in the trough as well.
The feeding frenzy in the US and EU is over for the time being, and the sharks are turning on themselves.
The Chinese sharks still don’t see it coming. Now if someone were to throw in a depth charge…..
http://big5.ce.cn/gate/big5/intl.ce.cn/specials/zxxx/201012/17/t20101217_22060465.shtml
this article written in Chinese is poublished by the Chinese Economy Network on Dec 20th, 2010. It’s saying that Jim Chanos has changed his point of view in the Chinese real estate market.
It says Jim Chanos commented “高度的政府管理是中國房地產市場的重要特徵，也是讓這個市場維持長久繁榮的重要保證 (the high level of government interference is an important, unique attribute of the Chinese real estate market, it is also an important assurance for the long term prosperity of the market)”
First, I can’t find an english version of this article.
Second, does this even sound like Jim Chanos at all?!
My guess is that the comment has been lifted off a Hong Kong publication and twisted to suit the Party mouthpiece concerned. I do not believe this is a direct quote, apart from the fact that it would be quite irrational for a western economist to say that central planning is a good.
The character set used indicates a cut and paste job.