China's Empty Cities

A good friend alerted me to the video below, which demonstrates the incredibly inefficient capital investment taking place in China as a result of its 4 trillion yuan stimulus program (~US$600bn). The video features the city of Ordos, intended to hold over 1 million people, but which remains virtually uninhabited.

The story of Ordos reminds me of the unoccupied homes on Dubai's palm-shaped islands. 60 Minutes did a great two-part segment on the country in August 2008. Here is a link to the video: A Visit To Dubai Inc.

While I remain convinced of China's long-term growth potential, there is little question that the government has fomented a massive investment bubble that will undoubtedly end very badly. While there are innumerable data points to support this view, a few stand out. Firstly, average Chinese home prices are nine times median household income, on par with the peak levels reached at the top of the US housing market in even the most speculative cities (more normalized levels should be ~2.5-3x income). Secondly, the volume of property sales has risen by 85% in 2009 and prices of new apartments in Shanghai have risen by nearly 30%.

While concerns over Dubai and Europe's "PIGS" dominate headlines, China scares me infinitely more. Dubai has public and private market debt of approximately $60-$80 billion depending on which source you believe (Dubai World, where much of the troubled debt resides, comprises just $25 billion of this total). On the other hand, Chinese banks unleashed over $1 trillion into their domestic economy in the first six months of 2009 alone! On an annualized basis this equals approximately 50% of GDP. After forcing them to aggressively lend earlier this year, the Chinese government is now encouraging banks to shore up their capital bases. Such a dramatic change in direction should not be dismissed lightly. (see: Chinese Banks Study Plans to Boost Capital).

Lending by government decree has undoubtedly contributed to the country's 8-9% GDP growth, but one has to question how efficiently such capital was invested. While there is little tangible data to support this assertion, most pundits speculate that a good chunk of this lending (perhaps a 1/3) was directed to real estate and stock market speculation. The video below provides some convincing anecdotal evidence to support this claim.