Being a bear on China gains favor


Not long ago, those who predicted that China’s economy was headed for a fall were in a lonely place.

U.S. economist Nouriel Roubini, widely praised for calling the U.S. housing meltdown, was dismissed as a serial contrarian when it came to his pessimistic China views. So was well-known hedge fund manager Jim Chanos. Lawyer and author Gordon Chang was derided as a Chicken Little for his 2006 book “The Coming Collapse of China.”

Suddenly they’re all Nostradamus.

Backed by data showing a slowdown in the world’s second-largest economy, doomsayers have taken center stage. Unbridled optimism has given way to fears over widening cracks in the Chinese economic miracle.


The gloomy sentiment has spilled into financial markets, whose investors have been running for the exits.

The Hang Seng China Enterprises index, which tracks the stock performance of major mainland companies listed in Hong Kong, is down 26% this year , making it the worst-performing market gauge in Asia.

The practice of short-selling -- betting that a stock will fall in value -- has become so pervasive among traders of Chinese equities that analysts at French banking firm Societe Generale deemed China the “world’s most crowded short.” For instance, nearly a third of the shares of China Overseas Land & Investment Ltd. were shorted in August and September, signaling doubts about the prospects of China’s largest property developer.

“There’s growing sentiment that the Chinese story doesn’t make sense,” said Chang, who is now invited to investor conferences and remains convinced of a looming crash.

Bears like Chang see slowing GDP growth, rising public debt and stubbornly high inflation as evidence China’s problems are about to get bigger.

Skepticism runs especially deep when it comes to real estate, which represents about a fifth of China’s economic output, by some estimates. In a pattern eerily similar to the U.S. housing boom, easy financing in recent years unleashed a Chinese development frenzy that sent prices soaring. Eager home buyers camped out for the chance to buy into planned developments, sight unseen. The typical 1,000-square-foot apartment in Shanghai costs $335,000, about 45 times the average resident’s annual salary.


Now China’s housing bubble is deflating. Home prices reversed in October for the second consecutive month as cash-strapped developers became desperate to unload homes. An index of 35 major cities showed 29 had experienced a decline in sales from a year ago; sales plunged more than 50% in six of them, including Beijing.

The Chinese government says it’s all part of the plan. After loosening the credit spigot during the financial crisis to keep the economy humming, it’s now tightening lending and clamping down on speculators.

But critics said the damage has been done. Behind China’s gleaming new high-rises, freeways and bullet trains, the bears see ghost towns, empty roads and superfluous rail lines. Public debt has exploded, raising fears of an overload that could weigh on China’s economy.

“A lot of that growth was just state-led investment on a massive scale,” said Victor Shih, a political scientist at Northwestern University and expert on Chinese local government debt who is firmly in the bear camp. “China is a behemoth now. If it gets in trouble, everyone gets in trouble.”

Faced with a growing number of clients worried about China’s prospects, Tao Wang, a Hong Kong-based economist at financial services giant UBS, recently released a research note aimed at calming investors’ fears. “We have had to refute different arguments about why China is about to collapse or implode every day,” she wrote.

But hardly anyone disputes that China’s current economic model is under pressure.

Its government-backed spending binge isn’t sustainable. And China is feeling the effects of a slowdown in Europe and the U.S., the two largest customers for its exports. Longer term, its days as the world’s low-cost factory floor are threatened by cheaper competitors and a shrinking labor force.


The global economy would benefit if China could rebalance its economy so that its 1.3 billion citizens started spending more. But they can’t because China has structured its economy to favor big businesses over consumers.

Beijing does this by keeping its currency, the yuan, artificially weak. That benefits exporters by making Chinese goods cheap. But a weak yuan fuels inflation at home and makes imported goods expensive. Authorities also keep interest rates low so that state-owned companies get cheap loans. But that means depositors earn puny returns.

It all adds up to less money in the pockets of consumers, said Peking University economist Michael Pettis.

“The repression of consumption is why I never bought the bulls’ story,” Pettis said. “China has to go through an important restructuring of sources of growth that will have very big implications.”

China’s breakneck pace of expansion will inevitably moderate. The question is whether that slowdown will be carefully engineered by China’s government -- a scenario Roubini called “mission impossible” -- or a harder, more painful landing.

Some say all the hand-wringing is overwrought and that China short-sellers such as Chanos, founder of the New York investment firm Kynikos Associates, have everything to gain by espousing gloom and doom.


“Chanos is a company analyst with no understanding of economics who treats China as if it were a company. It’s not; it’s a country,” said Arthur Kroeber, managing director of Beijing research firm GaveKal-Dragonomics, in an emailed response to questions.

Chanos did not respond to a request for an interview.

Bill Bishop, a closely followed independent tech analyst in Beijing, said that “the pendulum has swung too far” in favor of the bears.

“I think the fears are overblown. People in the U.S. are scared of China, and some people hope it drops,” said Bishop, co-founder of financial news service CBS Market Watch. He described himself as belonging to the “China-will-muddle-through camp.”

That faction says China’s leaders will do what it takes to avoid calamity. Others aren’t so sure.

“The reasonable bulls and bears among us agree on most of the facts,” Northwestern’s Shih said. “But at the end of the day, we disagree on the Chinese government’s ability to make tough changes.”