Property bubble spurring China's growth: James Chanos
NDTV Correspondent, July 25, 2011 (New Delhi)
Chinese realty a bubble, not short on India: Chanos
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Ten years ago, James Chanos made the first substantial bet that energy giant Enron was on the brink of financial ruin. He proved bang on target. His latest prediction is that the Chinese real estate market is headed towards a similar fate. Mr Chanos is the founder and president of the hedge fund Kynikos, which means ‘cynic’ in Greek. His firm manages roughly $6 billion and specializes in investments against assets that it considers overvalued, which means short selling in the financial lingo.
Here is the complete transcript of Mr Chanos' exclusive interview with NDTV's Prashant Nair.
NDTV: You have been famously shorting 21st century's greatest economic story. Do you still believe that 'China is on a treadmill to hell'?
Mr Chanos: Well, the 21st century is only about one-tenth through. So far, it’s the story of the 21st century. Look, China is a very dynamic country. It’s going to be a great power. It’s been a great power. But that doesn't mean, there can't be some pretty major speed bumps along the way. And I think that we are probably looking at a very very large pot hole -to mix a metaphor in that. China in the past few years is increasingly relying on a property bubble to spur its GDP growth. And I think that's going to be problematic going forward for not only China but possibly countries in the region as well as countries that export to China, particularly industrial commodities.
NDTV: From the time you started calling China's property/construction led GDP boom a big bubble, the government & the central bank has acted. Do you still believe China is a story of 'overheating and overindulgence'?
Mr Chanos: I think that they have tried to tamp down the property growth. But in fact, the fixed asset investment as a percent of GDP is actually still increasing ironically. So as much as they try to tamp down the price increases in the property market and try to restrict mortgage availability, it appears to be popping up elsewhere.
And much of this is due to the fact that there are two governments in China.
There is the central government in Beijing which is desperately trying to cool off inflation and cool off the property market.
But then you have the local governments, who are in bed with the developers, and who basically sell land to joint ventures increasingly backed by risky debt as we now know in order to fund these real estate ventures.
And I think that's the problem. They are still going, as we say, pedal to the metal. They are going full bore at the local level while the central authorities are trying to restrict the growth out of Beijing.
And much of this is due to the fact that there are two governments in China.
There is the central government in Beijing which is desperately trying to cool off inflation and cool off the property market.
But then you have the local governments, who are in bed with the developers, and who basically sell land to joint ventures increasingly backed by risky debt as we now know in order to fund these real estate ventures.
And I think that's the problem. They are still going, as we say, pedal to the metal. They are going full bore at the local level while the central authorities are trying to restrict the growth out of Beijing.
NDTV: Ok, if we are talking about the debt bomb, when does China's bubble burst? You had called for the unraveling by 2011-end and we are pretty much there. Would you want to put a new timeline?
Mr Chanos: Well, look China has been despite what some of my critics say, China has not been a bad place to be a bear in the last year and a half.
The Chinese market over the last year and a half is down. The property developers and banks, which we were primarily short, are down. Most western markets with the exception of Spain and a few others are up over that time frame. Certainly the S&P 500 is. So if you are a bear China has not been a bad place to be hanging out for the past 18 months. I want to clarify that.
Second of all, a year and a half ago people pooh poohed the fact that there was even a property bubble. I mean, there was...I was attacked for not speaking Mandarin...for never having been to the mainland.
And as I pointed out, no length of residency or number of visas can compensate for a lack of judgement. There were plenty of Miami natives who lived in Florida their whole lives, who lost everything in the Florida real estate bubble bursting. So, I think again a lot of people attacked me...but not the argument. As 2010 has moved into 2011, I think it’s becoming a little more obvious to the mainstream press that there is a bubble.
And the question seems to have shifted, not is there a property bubble, but what do we do about it. And does it deflate gently or does it pop.
NDTV: Your timing on Enron, Tyco and the subprime crisis has been impeccable. So, do you think in the next ten years or so, we might get to see a big change in the world economic order? If it happens - what do you think we are looking at?
Mr Chanos: The challenge for the Chinese government, as for a lot of developing economies, is to transform from primarily an investment led economy to a consumer led economy. And that is what everybody is counting on. The problem with that argument is that it’s been made for years now and consumption as a percent of China's GDP is declining, not increasing. And so I think they are going to get there but I think there is going to be some pain along the way. And as all great developing economies including the USA in the 19th century and early 20th century, I mean those are histories of booms and busts. It’s often led by capital investment where investors get wiped out and a whole new group of investors come in and the economy continues to progress. And that's my only caution here. China might do very well. But western investors in China might not do very well. As a famous historian quipped to me fairly recently, he said, boy, the only westerners who have got their money out of China were the 19th century opium dealers and they had the Royal Navy behind them. And there is certain truth to that.
NDTV: If the Chinese bubble bursts, how do you think commodity prices will pan out?
Mr Chanos: Well, I would tell your viewers in the iron ore market back in India to lock in whatever they can. I think, for example that industrial commodities it’s no secret that India along with China is probably on the margin the largest driver of demand. And it’s all due to the construction boom. So things like copper, iron ore, to some extent steel, these are all being buoyed by the construction boom in China. And you know what we know about these things historically is that there is no gradual end in demand. The demand just ends and falls off a cliff. And so you know, I think it behooves the commodity makers to try and lock in as much as they can. But you know, will their contract be held unviable. Who knows? As they say, with construction going full bore and the amount of commodity production that is now gearing up to meet that construction, if that ends at some point or even begins to decelerate reasonably well, price drops could be enormous in some of the commodities.
NDTV: Gold is consistently making record highs. Is it the only safe investment in current times? How much of a precious metals bull are you?
Mr Chanos: Well, I notice you said investment and not money, and that was the big controversy last week with Mr Bernanke. No, we don’t have a view on the gold market. That's a monetary phenomenon. And it’s hard to analyse the sentiment. We are doing work on the Chinese property market and deriving our investment ideas on the short side from that, which we can analyse. I can’t really analyse all the factors in gold. I'll leave it up to someone else.
NDTV: Mr Bernanke talks up QE3 and then talks down QE3 just a day later. Where are you on the QE3 fence? And how do you make money from it?
Mr Chanos: Well, you know I was one of the few democrats who signed that letter back last November criticising QE2 and I criticised for different reasons. I think the other signatories, because I think all of this talk of QE2 and QE3 continues this belief amongst investors- and its worse in China by the way- that some sort of governmental authority will always be there to make the right decisions or better your bad decisions, as we saw the property bubble in the west. I mean the Fed Reserve did not see this coming and consequently, I mean everybody counts on whatever tools have worked in the past - printing of money or QE whatever you call it - to work in the future but the problem is when you telegraph policies, people tend to get their financial house in order to offset whatever impact whatever those new policies will have and I think that you know Mr Bernanke is trying all the tools he can but if people don’t lend him money, then it’s going to be very tough.
NDTV: Marc Faber recently quoted you saying that Jim Chanos always says China is Dubai times a thousand. In his view, US is Greece times a thousand. What do you make of the debt deficit and the threat of a US default?
Mr Chanos: Yeah, I am not the one to argue with that though Mark is a good friend and you know he is right in that one of the great accounting frauds is that of government accounting. I teach a course on history of financial frauds in Yale and my last lecture is what I call Crossing the Ethical Rubicon from the private sector to the public sector and how governments - and in particular the US government - keep their books. If corporations keep their books this way, they would all be in jail. And in the US' case, it is due almost entirely to the fact that we do not keep our medicare promises on the financial books. So when we incur medical promises to our retired people in the future and health care costs go up, a corporation has to actually calculate that and make a best guess and put it in its books as an expense and a liability. Governments don't do that. And so I give you a good example, last year the US deficit was $1.3 trillion roughly. If you take some inter-government transfers amongst them, the deficit was $1.6 trillion under the government's cash basis book keeping, but if you looked at what the accrued deficit was, the actual economic liabilities we incurred against revenues, it was actually north of $5 trillion and rather than $14 trillion of US government debt, we really have is something north of $60 or $70 trillion and that would be a debt level 5 times the US GDP. So, these are real issues and when people talk about the deficit being a long term threat this is what they are talking about the amount of IOUs piling up in Western Governments for long term promises. In the US' case, it is health care.
NDTV: So, do you see the threat of a US default?
Mr Chanos: Look, no matter what happens, the payments are going to be made come early August but I think that the issue is going to be how do we restructure US' liability and get a sneaky default. I noticed in the latest proposals yesterday that they are talking about changing the consumer price index. Millions and millions of Americans get their cheques based on the consumer price index inflation. Their benefits are indexed on that but they are now looking at a different index which of course you guessed will bring the consumer price index down and that is just a simple back door way of inflating your way out of the problem. So the history, you had mentioned the gold market earlier and again we are not macro thinkers but I am a bit if a financial historian and financial history tells us that when faced with either depression or inflation, government have almost always tried to inflate their way out of their debts.
NDTV: Your firm's name is Greek for cynic so I have to ask you are you 'Kynikos' on Greece and the PIGS? And what is your opinion about the bigger Eurozone economies like Italy and Spain coming under the radar?
Mr Chanos: By the way, the cynics in ancient Greece were held in high regard as people who pursued disciplined independence of thought in a democracy and didn’t take on face value what others told them but inquired themselves, but if you apply that to Europe- the Greece situation- I am pretty familiar with if we don’t know trade sovereign CDSs so my views are simply that of an observer and not an investor but i do think that the recent stress test results that we had was that an enormous amount of data was dumped into the market and it became very apparent that the exposures for some of these banks, if you include commercial loans and mortgages, to the so called PIGS was rather dramatic and again we are getting back to the accounting tail wagging the economic dog The EU regulators going to let the banks hold this paper at fictitious levels. Whether there will be recoveries, if somebody does default? I mean, it almost looks increasingly, like my country men in Greece are going to have to restructure something. Does Greece and Portugal…do they leave the EU...or as someone wrote in London this week, does Germany leave the EU which might even make more sense and let the others keep a Latin-EU currency block. I don’t know, I don’t think anyone knows right now. I don’t think the Europeans know.
NDTV: Is the Euro the biggest short in history?
Mr Chanos: No, no...I don’t believe that the Euro is the biggest short in history. I think there are far better shorts in history but I think again because it again depends on what you get if the Euro dissolves. You are going to get different currencies - somewhere, something -some worthless, some more so... Am not too sure that is a cut and dried thing...
NDTV: In your case, when it comes to India, I don't want to even hear if you like India. So what is your opinion?
Mr Chanos: Well, the good news is I don’t like India from my perspective. We are not short on India and things in India. We are hands full with neighbours of India to the north and east. India is a much more vibrant economy and a much more balanced economy. It does have its successes, it does have its needs, but it also has - from my perspective - a rule of law and a respect for contracts and then there is something for sure that is lacking in China that western investors keep finding out with these frauds that keep being uncovered. So, as an investor sitting in New York and London, I would much more be apt to look at it as an intriguing opportunity in India than in China.
NDTV: So, at some stage could you cover your China shorts with India longs?
Mr Chanos: I don't know that they are going to be correlated but it’s certainly a thought, we will leave it at that.
NDTV: What about the emerging markets basket. Are you seeing shorting opportunities there?
Mr Chanos: We are seeing lots of one off ideas in the emerging markets. A lot of companies get floated with very questionable governance issue. There are some companies in Central Asia that we are short and where the western shareholder is going to be in after. Though when it comes to activities and delusion and pay outs and where the accounting looks sketchy at best. I don’t want to give names but there is plenty to do in the emerging market.
NDTV: One final question. Do you believe the 2008 financial crisis was the worst we will ever see in our lifetime? Or is another just around the corner?
Mr Chanos: I don’t know if another one is just around the corner and I think your lifetime will be longer than mine I am guessing given this severity of this crisis keep getting bigger and bigger and we don’t seem to do much about the underlying causes and government guarantees which give rise to moral hazard - both in the East and the West. And, we don’t seem to want to have an honest accounting of our affairs as I have indicated, the private sector to the public sector my guess is that the critics will over time keep getting worse until we finally get a major one that makes us revalue our systems and stops benefitting financial sector to the detriment of the rest of the economy and that hasn't happened yet.
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