Why Jim Chanos is Wrong About China's "Ghost Cities"

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China's "ghost cities" present the West with the shocking images of vast urban areas that sit nearly empty.

In a striking report, shown recently on CBS News' "60 Minutes,"there are rows of high-rise apartment buildings, tracts full of suburban American-sized detached homes and  imposing government edifices in China's western  desert that are empty and utterly devoid of any signs of life.

Their existence has raised more than a few red flags among investors.

Famed hedge fund manager Jim Chanos, for one, warns that these ghost cities represent the ominous specter of a bubble and that China should be relegated to ten-foot pole status.

"Anything that's depending on the Chinese economic miracle I would be careful of," Chanos said in a recent "Squawk Box" interview.

A long time China bear, he's part of an amen corner of those who say that China's ghost cities are a sign of some trickery in the way the Chinese government presents its GDP to the world.  

They claim that it's heavily dependent on infrastructure construction, and what we are seeing now is build-out running amok, without purpose, a complete waste of money.

As a result all of them see China as on the way out, a risky proposition, a sinking ship, or a fool's errand.

But, as it turns out, all of them are dead wrong

According to Keith Fitz-Gerald, Chief Investment Strategist at Money Map Press, all of them lack a complete understanding of the realities on the ground there.

As long-time resident of Asia, and a keen, street-level observer of the Chinese economy, Keith would know. Not surprisingly, his view is quite different from the doom 'n gloom crowd.

"They perpetually make this argument about the ghost cities," says Keith, "What makes these cities seem different is the numbers, and that they're being built on a scale that's just incomprehensible to Western analysts." 

But the "ghost cities" are not a uniquely Chinese phenomenon, and their scale is really only a matter of degree.

The truth is there are large, empty developments all over the world, including the United States. In those countries, "ghost cities" happen wherever developers may have misjudged demand. The difference is China's "ghost cities" appear on a grand scale, because China itself is on a grand scale.  

China's "Ghost Cities": The Promise of Great Expectations

On the contrary, Keith believes China's "ghost cities" herald great expectations.

"There are very real reasons why China builds these cities in advance. The Chinese government is expecting the greatest migration in human history, as over a billion people urbanize by 2020. We're already several years in." Keith said, "The government has planned for this; they know people are coming and they're building in advance."

In reality, China is expecting the "ghost cities" to be full within the next 35 years - a long bet by Western standards. The megalopolis of China's East Coast is more or less at capacity, and so the Chinese government is seeking to build up its largely empty western regions.

"The other thing Western analysts don't bother to understand is that the Chinese plan everything in five-year cycles." Keith said, referring to China's famous Five-Year Plans.

"Two or three planning cycles ago, they created a 50-year initiative - the Go West Initiative - to plan for building up the country's west, as opposed to their urban eastern seaboard. Everything west of Xi'an is a targeted economic zone." Keith said. "They're just planning on timescales that Westerners don't get."

According to Keith, the issue of "ghost cities" also has to do with a misunderstanding of the way the Chinese deal with property, as opposed to how it's dealt with in the United States. China takes more of a "use it or lose it" approach, contrasted with a "bank it and wait for demand" approach in the United States.

"The situation with property in China is changing in places, somewhat, but historically there are no property taxes...at least as the West knows them. In China, once you've gained control of a piece of property, developers typically have a finite period of time to begin construction or lose the property. You don't have these situations like in the United States, where a developer can buy a piece of property and sit on it for years, effectively banking it until the demand is there. In China, you have to build, even if it means the buildings lie empty. And when it's time for people to move in, they'll see if the building's held up over time. If it's not, they'll knock it down and, many times, build a new one."

He continued, "The other thing to consider is that historically developers didn't have to pay taxes on empty buildings, so they almost had an incentive to build and leave it unoccupied for lack of a better term. That's a wrinkle that someone who hasn't been to China wouldn't see or understand. This is obviously changing as China begins to implement Western-style taxes."

So why do these China bears continue to pound the table about a property bubble, heedless of the street-level reality in China?

Beyond fundamental cultural misunderstandings, it's helpful to take a page from Lucius Cassius and ask, "Cui bono?"  or who benefits?

"Avowed short sellers," Keith said, "people with a vested interest in creating negative market sentiment because they are betting on China's failure."

"A lot of people calling for China's demise on these grounds have been calling for it for forty years. I really feel sorry for them. It must be terrible to be wrong for so long." Keith continued, "The notion that China will fail on real estate is missing the point. The nation is not going to fail, not because of Western analytics. They don't apply. China is uniquely China."

A Deeper Misunderstanding at Work

Keith highlighted another important misreading, uglier perhaps than simple short selling or ideological differences. He said, "Some people want to assign China the role of "enemy," because we don't have Russia anymore. But these people don't seem to understand that China has absolutely no interest in playing that role. We think of the dollar as a weapon. They see it as a liability."

He continued, "Other people will say 'Oh, China's communist. It can't possibly work.' But where is it written that you can't be communist and capitalist at the same time? I submit with 40 plus years of spectacular growth that China's figured out how to make communism and capitalism work."

The naysayers have even misread China's economic cooling-off.

 China's economic growth is off a few fractions of a percent, bringing out the short sellers and talking heads with their dire predictions. These are best shrugged off.

"China makes no bones about central banking decisions in the interest of its economy, Keith said.  "Beijing is tapping the brakes, beginning to implement tools that Westerners should view as a proper market function."

Even when the essential truth of the matter is there to see, there's little doubt that the big-haired prophets of China's doom will remain with us as they always have.

In the meantime, the "ghost cities" of China will wait on the rising tide.

Let us know what you think of China's "ghost cities." Do they represent the beginning of the end for #China, or do they herald China's westward expansion? Join the conversation on Twitter @moneymorning or write on our Facebook Wall.

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