'China Dream' Versus 'China Bubble': Pundits Choose Sides

China is expected to take over Japan as the second largest economy in 2010; even with China’s optimism, dynamism and growth, there are many investors who believe the China market is a bubble waiting to burst – while others finance gurus remain steadfastly bullish on China.

To me, this emerging debate seems almost like a boxing match: “In this corner representing the ‘China Inc/One Billion Customers/China Boom’ school of thought are globally influential commentators and financial wizards Thomas L. Friedman, Jon Anderson and Jim Rogers.”

“And, in this corner, representing the ‘China Bubble’ and ‘Short-Selling China’ arguments are hedge fund heavyweights, academics and finance gurus like James Chanos, Michael Pettis, Vitaliy N. Katsenelson and Gordon Chang.”

“Who is going to win this argument, folks?”

“The ONLY thing we know for certain is that everyone has an opinion…let’s get ready to rumble!”

OK, so I’m being a bit dramatic.

But I’m trying to drive home an important point: it seems just about every China watcher has come out recently with an opinion/prognostication about the “China bubble” or lack thereof.

No doubt readers of this column have felt uneasy at the thought of a “China bubble” followed by another global downturn. Nobody wants this outcome.

In the case of the current global financial crisis, there were a few people, like economist Nouriel Roubini who accurately predicted what was in store…while multitudes of other “brilliant” pundits got it wrong.

As with most arguments between brilliant people, the arguments make sense because they are supported by facts, logical reasoning and are being made by inherently credible individuals.

With so many news stories over the past three months on this topic, I wanted to summarize the key opinion leaders and their opinions for the sake of clarity.

The China Bubble Theory – Real Estate Worries

• American hedge fund manager James Chanos – who predicted the crash of Enron and Tyco – set off alarm bells when he claimed that China is like “Dubai times 1,000 – or worse.” Chanos clearly believes China is heading for a crash

• At a recent speech at the London School of Economic, James Chanos warned that “Without a modicum of doubt we have a credit-driven property bubble right now"

• Chanos is joined by a number of other prominent voices, including: Peking University Professor Michael Pettis; Harvard Professor Kenneth Rogoff; Finance Consultant James Rickards; Author Gordon Chang; investment analyst Marc Faber and Portfolio Manager Vitaliy N. Katsenelson

• According to James Rickards: China is in the midst of “the greatest bubble in history;” Rickards is the former general counsel of hedge fund Long-Term Capital Management LP

• Rickards was also quoted as saying: “As I see it, it is the greatest bubble in history with the most massive misallocation of wealth. It is a bubble waiting to burst.”

• In a recent survey of investors who subscribe to Bloomberg’s news and data services, 62 per cent believed a China bubble was forming

• The Chinese Government has raised banks’ reserve requirements twice this year

The issue of a “bubble” is mostly out of concern for China’s real estate sector; sales increased by 79 per cent in 2009 and in some markets, real estate prices have been increasing 8 to 10 per cent a month. Chanos and the others are concerned that a meltdown in China’s real estate sector would create a domino-effect and damage the rest of China’s economy – and seriously undermining the economy of its neighbors. Real estate has been one of the major recipients of China’s stimulus lending and spending. The demand for Chinese housing is actually outpacing supply – with many Chinese believing that prices will increase tomorrow.

“Never Short a Country with $2 Trillion in Foreign Currency Reserves”

Again, the concern is centered on the possibility of a real estate collapse in China. It’s important to note that China’s real estate market is not the real estate market of the United States. They do not equal each other.

In China, buyers of real estate have to put down about 30 per cent initially…very different than US consumer behaviour.

Influential American columnist Thomas L. Friedman wrote the following to counter James Chanos’ controversial outlook:

“First, a simple rule of investing that has always served me well: Never short a country with $2 trillion in foreign currency reserves. Second, it is easy to look at China today and see its enormous problems and things that it is not getting right. For instance, low interest rates, easy credit, an undervalued currency and hot money flowing in from abroad have led to what the Chinese government Sunday called “excessively rising house prices” in major cities, or what some might call a speculative bubble ripe for the shorting. In the last few days, though, China’s central bank has started edging up interest rates and raising the proportion of deposits that banks must set aside as reserves — precisely to head off inflation and take some air out of any asset bubbles…………. But, hey, some people said the same about Enron. Still, I’d rather bet against the euro. Shorting China today? Well, good luck with that, Mr Chanos. Let us know how it works out for you.”

Jim Rogers, co-founder of the Quantum Fund with George Soros is still very bullish on China.

Rogers said that the Chinese economy is not in an imminent threat of collapse.

According to Rogers: "It is absurd to say China is in a bubble when the stock market is 50 to 60 per cent below its all-time high. If you have a bubble you have things going through the roof. You have everybody screaming fire every day.”

"We are closer to some kind of top than we were and we are overdue for a correction. But are we going to have one? I don't know," he said.

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