A shiny new city fuels talk of a bubble

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It is a lustrous new city boasting row upon row of apartment units, fresh roads, highways, office towers, and a magnificent city hall. Ordos, located in China's coal- and mineral-rich province of Inner Mongolia, was built in only five years and largely with government money.

Such infrastructure projects have made China the envy of the world, allowing the country to enjoy GDP growth of 8.7 per cent last year, a sharp contrast to much of the West, which struggled to emerge from the worst economic crisis since the Great Depression.

Yet while Ordos is large enough for more than one million residents, large parts of it sit empty, serving as a testament to the risks facing China's economy.

If ever there was a place that symbolized what many say is an economic and real estate bubble, it is this city. The old municipality of the same name still bustles 30 kilometres away; its residents say they can't afford to move to the new metropolis. Many of the apartments in the new Ordos are owned by speculators that are content to let them sit empty - and presumably appreciate in value - until they are flipped for a profit.

For the growing ranks of Chinese economic doomsayers, Ordos is a monument to all that is wrong with the Middle Kingdom. Instead of boosting domestic consumption of goods, they say, the Chinese government's $586-billion (U.S.) stimulus package and loose lending policies have exacerbated an already overheated real estate market in China, where prices have been rising in some cities at a 20 per cent annual rate.

Many China watchers fear the economy is running on a "sugar high" from government stimulus funds and free-flowing credit that simply can't be sustained. A crash would stall a nascent recovery in Europe and North America.

"The growth has all been government driven with stimulus spending. You have artificial growth, a lot of liquidity and real estate markets becoming hot. This is not a good sign," said Todd Lee, managing director of the Greater China division at IHS Global Insight, an economics firm.

The great fear is that China's economy will run out of gas at the same time as a major correction in real estate and stock market prices. Exports, still the true growth engine of the Chinese economy, remain relatively weak due to tepid demand from the West. China's exports fell 16 per cent in 2009 and have only recently begun to recover. They posted their first increase in 14 months in December, rising 17.7 per cent year over year to $130.7-billion (U.S.).

"Bubbles are best identified by credit excesses, not valuation excesses," James Chanos, a New York hedge find manager and well-known short seller, said in a recent interview with CNBC. "And there's no bigger credit excess than in China."

The money has certainly been flowing in the People's Republic. Chinese banks lent a record 9.59 trillion yuan ($1.4-trillion) last year in hopes of stimulating China's economy through the global downturn.

The ample liquidity continued into the new year. Chinese banks lent a staggering 1.45 trillion yuan in the first 19 days of this year, according to reports in Chinese media, on pace to smash the government's annual target of 7.5 trillion yuan.

Fitch Ratings recently warned that Chinese banks face the largest "bubble risk" of any Asian country, considering the 32 per cent loan growth in 2009 and 20 per cent loan growth target in 2010. The agency said credit growth of more than 50 per cent over a two-year period - in an economy where bank credit is already considerable relative to GDP - "almost inevitably involves some misallocation of credit."

Australia, whose economy managed to dodge a recession due in part to its close trade ties with China, has taken notice. Citing uncertainty about the Chinese economy, among other factors, it surprised economists by skipping a widely expected interest rate increase this month.

Even Yun Guangzhong, the mayor of Ordos, whose constituents can't afford to move to their new city, has publicly criticized China's focus on infrastructure spending and GDP growth that "cannot substitute for quality and efficiency."

"GDP alone cannot represent the people's aspirations or the raising of their income. Fixed-asset investment does not mean industrialization and urbanization have improved," Mr. Yun said in a speech last month.

The bubble concerns have provided fresh fodder for those who have long called for China's roaring economy to hit the wall. Gordon Chang, author of the 2001 book The Coming Collapse of China , recently penned an opinion piece that appeared in several major Asian newspapers, warning that China's economic growth is untenable and that property and stock market bubbles are poised to pop. "However fast the economy is growing, China's policies are unsustainable," he wrote.

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Bubble worries extend well into China's central government, which has already begun clamping down on lending by state-run banks. Banks were ordered to temporarily halt new lending in the latter half of January, and the reserve requirements that banks must maintain to back loans have been increased twice this year. Monetary tightening policy in China is officially under way.

China's feverish stock market appears to be getting the message. After posting world-beating gains through much of 2009, the Shanghai composite index has been among the planet's worst performers so far in 2010.

In a further attempt to quell real estate speculation, China has also raised the minimum down payment on a second mortgage to 40 per cent. Anecdotally, the market has already shown some signs of cooling.

It is the ability of China's government to control credit so quickly and effectively that gives comfort to many China experts. They also cite the fact that Chinese property buyers tend to make large down payments, in sharp contrast to the U.S. home buyers at the root of the American real estate bubble who bought homes while putting little or nothing down.

Wang Tao, China economist at UBS, forecasts China's inflation will remain moderate this year at 3 to 4 per cent, while GDP growth will reach 9 per cent or possibly higher. In a recent report, Ms. Wang said she expects at least two interest rate increases during the second quarter that will "manage rising inflation expectations and credit control to ensure lending growth does not get out of hand."

If loans were to continue at the torrid pace of early January. however, "runaway lending and investment could result in much higher inflation and a big asset bubble down the road," Ms. Wang warns.

And this massive economic stimulation is not just a Chinese problem. "A huge debt bubble is inflating China's economy and, by extension, the world's," James Grant commented last month in his influential Grant's Interest Rate Observer.

Na Liu, China analyst at Scotia Capital, said Chinese policy makers have already "done a lot" to cool loan growth and property princes since mid-January, including a move by the Bank of China to stop offering rates discounted by 30 per cent on mortgage loans to first-time home buyers. The best rate now is a 15 per cent discount.

In an interview, Mr. Liu said "the overall property market in China is not a bubble."

However, the red-hot markets of Beijing, Shanghai and other coastal cities still pose real problems - "the bubble is in the major coastal mega-cities." Property prices in Beijing are now between 15 and 18 times the average annual income, Mr. Liu estimates. That compares to "normal" ratios of seven or eight times. At current average price levels and incomes, it would take more than 16 years of income to buy a 1,075-square-foot apartment in Beijing.

"People with a normal income cannot buy a home in Beijing ... that is not a healthy market," he said.

Still, Mr. Liu is less concerned about China's empty cities, shopping malls and office towers. There have been plenty of examples of overenthusiastic building in the West too, he said, citing the Millennium Dome in London, Mirabel Airport in Montreal and the "stump" of an office tower that sat on the north side of Adelaide Street in Toronto's downtown core for nearly a decade until it was recently developed into an office tower.

"Economies can survive overbuilding as long as the banks can manage the writeoffs on the loans," he said.

With a file from reporter Brian Milner