Is China the Next Dubai?

12/16/2009 1:00 pm EST

Focus: MARKETS

Nicholas Vardy

Editor, Bull Market Alert, The Alpha Investor Letter, and The Global Guru

Nicholas Vardy, editor of The Global Guru, says China faces the same overinvestment as the desert state, but the consequences of its collapse could be much, much worse.

Superficially, Dubai's rapid development from speck of dust in the desert to mirage made real is not that different from China’s. Cheap financing combined with world-class aspirations fueled Dubai's property boom that included the world's tallest building, the Burj Dubai. Property prices doubled between 2005 and 2008. The emirate's rulers even targeted a China-beating annual GDP growth of 11% to 2015.

China bulls will dismiss uncomfortable comparisons with Dubai. After all, the population of China is a thousand times greater than the tiny emirate's. And Dubai's $50-billion GDP is less than the wealth China has generated in the last three months.

Yet even as the media falls all over itself to praise the remarkable efficacy of China's $585-billion stimulus package, Bill Gross of PIMCO made investors squirm when he observed that the all-knowing philosopher-kings running the Chinese economic show may inflate... gasp!... a bubble of their own.

Much like Dubai, the problem in China is best summed up in a single word: "overinvestment." Even as consumers are closing their wallets, China is building more steel, more factories, and more malls for which there is almost no demand. Much like in Dubai, many Chinese skyscrapers stand empty, even as whole new cities are being built where the vacancy rates are as high as 75%.

Yet, not only are the Chinese building a lot of stuff they don't need, they also are getting a heck of a lot less bang for their buck. From 2000 to 2008, it required $1.5 in debt to produce $1 of GDP in China. Today, it takes $7 of credit to yield $1 of growth in GDP. No one has done that poorly since, well, the bad old days of the Soviet Union.

[Now,] Jim Chanos, founder of the investment firm Kynikos Associates and iconic short seller, has put the Chinese market in his sights. Chanos made his reputation—and a good chunk of his fortune—as one of the first Wall Street analysts to see that Enron's earnings were pure fiction.

Chanos believes that inconsistencies in China's statistics—like the surging numbers for car sales but flat statistics for gasoline consumption—confirm that the Chinese are simply cooking their books.

If Chanos is right, the collapse of the Chinese economy will be 100 times worse for the global economy than was Dubai. If China's economy stops running hard, it will have profound effects on its ability to finance the exploding US deficit. In Chanos's view, the slowdown in China may be as big of a watershed event for world markets as the subprime collapse was in the US. Little wonder that he is betting the farm on shorting China's economy.

That doesn't mean that China won't eventually emerge as a global economic power. But as John Maynard Keynes observed, "In the long run, we're all dead." If you have a shorter time horizon, batten down your investment hatches. The seas may get rough.

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