Will China's Cranes Keep Rising?

06/07/2010 12:04 am ET | Updated May 25, 2011

Many investors are betting heavily this will be the Chinese century.

But before racing to invest in China, listen carefully to James Chanos, a New York-based hedge fund manager whose fame and fortune soared after being among the first to bet against Enron and other high-flying stocks that later collapsed. Since late last year, Mr. Chanos has stirred intense debate around the world with his repeated warnings that China's hot property markets represent a dangerous "bubble."

During a recent conversation with students in a business journalism class at Columbia University's Graduate School of Journalism, Mr. Chanos said China's property markets, primarily high-rise buildings such as offices and condos, are "on a treadmill to hell." He has made similar comments in interviews with Charlie Rose, The New York Times and other news organizations.

Some respected commentators, including New York Times columnist Thomas Friedman, disagree with Mr. Chanos. They say Chinese officials are keenly aware of the potential threat and already have taken significant action to avert trouble. Whatever the case, Mr. Chanos's thinking - and the views of his critics - are worth a closer look because of Mr. Chanos's remarkable track record and because of China's rapidly growing impact throughout the world.

The Outlook

Mr. Chanos, a Yale graduate and the founder of Kynikos Associates, has achieved international fame as a "short seller," a technique that essentially involves betting that an investment's price will sink. Mr. Chanos says he doesn't know precisely when the bubble will burst but that short sellers can prosper with strategically-placed bets.

How? He says commodity stocks, such as those of companies in the iron ore, copper, nickel and steel businesses that have prospered due to Chinese construction, probably will tumble when the Chinese building boom halts. He also is looking for opportunities in stocks of Australian and Brazilian companies that sell raw materials to China. He declined to name specific stocks.

Patrick Chovanec, a professor at Tsinghua University's School of Economics and Management in Beijing, has also kept a close check on China's booming property markets. Prices of residential houses in some areas like Shanghai have dipped recently. But he says it's "premature" to conclude the boom is over, given that in 2008, buyers regained confidence after a slight price drop off, and that housing prices in China subsequently recovered.

While Chovanec does not characterize himself as "short on China," he is skeptical that the Chinese government is taking enough steps to curb speculation.

Even as China adopts new policies to try to steer clear of further inflation, the country is not immune, according to James Rickards, a Senior Managing Director at Omnis Inc. Rickards, who described China as "the greatest bubble in history" to Bloomberg, said in a phone interview that exogenous factors outside of China's control may still cause a collapse in the country's housing market or stocks.

Some respected commentators have taken strong issue with Mr. Chanos's comments. Writing in The New York Times, Tom Friedman said he is "wary of the argument that China's economy today is just one big short-inviting bubble, à la Dubai."

"I am reluctant to sell China short, not because I think it has no problems or corruption or bubbles, but because I think it has all those problems in spades -- and some will blow up along the way (the most dangerous being pollution)," Mr. Friedman wrote. "But it also has a political class focused on addressing its real problems, as well as a mountain of savings with which to do so (unlike us)."

Experts who predict continued prosperity for China argue that the Chinese government already has taken influential steps to restrain surging prices. "The Chinese government is not being draconian yet," said Jim Rogers, co-founder of the Quantum Fund, in a phone interview. "They're taking gradual steps."

Rogers said China's urban centers near the coast are indeed in a property bubble, but that the idea China's stock market is in trouble is "embarrassing." He said it is more likely that the U.S. is in a bubble than China, considering that China's stock market is down 65 percent from its record high.

While Mr. Rogers says there may still be investment opportunities in China's real estate market, he said he isn't buying property there. When asked whether commodity values could drop if China's property market suffers, Rogers said maybe, but many more factors are at play in determining the commodity market.

Daniel Rosen of Rhodium Group, a New York-based firm that studies Chinese markets, said in an email that one shouldn't underestimate the durability of broader demand for commodities--and that strategies like Chanos' to short commodities related to the Chinese property market are not well-founded.

The Chinese government can control the real estate bubble -- and even with price corrections in the upper-end of the housing sector, there should be "a fairly soft landing" in the mass market, according to Rosen.

Can China Do More?

Some experts believe China could do more to discourage buyers from flipping real estate. The country still wants to retain its engine of growth, so it essentially has "one foot on the accelerator and one foot on the brake," said Patrick Chovanec.

Among the ideas suggested by Chovanec: China should encourage its citizens to invest abroad by giving them a greater range of investment options in global markets. At present, Chinese people have few outlets to place their savings, which is why many have resorted to pouring money into domestic real estate.

Whether Chinese leaders will have the wisdom to steer clear of a crisis and help China's economy to remain competitive in the longer term remains to be seen. But this much is clear: Chanos's highly charged views have touched off a debate that is likely to attract increased world-wide attention amid continued nervousness about the roller-coaster ride of world stock prices recently.