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Insight on Ordos

May 13, 2010

Ting Lu, an economist at Bank of America-Merrill Lynch, released an extremely interesting report on his visit to China’s oft-cited “ghost city” in Ordos, Inner Mongolia.  This is precisely the kind of on-the-ground analysis that is absolutely irreplaceable in coming to grips with the complex reality of China’s economy.  You can read the complete report here.

Lu’s analysis is being cited as evidence that the “China bears” have it wrong, that — to rephrase my old boss Bill Kristol’s formulation in the U.S. health care debate– “there is no China real estate crisis.”  He writes that while Ordos “is a must see for emerging market investors,” it is “unique and not representative of China,” and argues that reporters who have highlighted it as an example of the country’s real estate bubble “could easily distort the overall picture, exaggerate problems, and overly generalize findings.”  Of course, every place features unique circumstances, especially in a country as large and diverse as China.  And Lu’s explanation of the role the local coal mining industry has played in fueling Ordos’ amibitous expansion is extremely informative.  But you might be unsurprised to learn that, as one of the “experts” interviewed in Al Jazeera’s break-through report on China’s “ghost city,” I don’t concur with Lu’s conclusion that Ordos is “an outlier” and little cause of concern.  In fact, the substance of what he reported actually confirmed my view that what is happening in Ordos — unique circumstances not withstanding — reflects some of the most consistent and worrying trends in China’s real estate boom.

In particular, I was struck by one observation Lu made:

There is one important fact about the local property market.  Despite being depicted as the “ghost town”, the impression would be that there are many unsold properties and the bubble there might burst soon.  In reality, however, all homes in the new town are sold out.  A couple of days before our visit, all units in a newly finished estate were sold within just one week.  Leverage is not high there, as … many home buyers simply pay cash … Owners in Kangbashi [Ordos’ new town] are so cash-rich that they really don’t bother to rent their apartments.

This is precisely the picture I’ve been painting over and over again, beginning with my Far Eastern Economic Review article on “China’s Real Estate Riddle” (in June 2009), through my more recent observations on Hefei and Hainan.  In fact, far from missing it, I highlighted this phenomenon in my very first post on Ordos, linking to Al Jazeera’s report.  Lu is reassured that the houses are all sold.  I’m perplexed by the fact that they’re all sold, for cash, but have been left empty — not just in Ordos, but all over China.  My explanation — the key to the “riddle” — is that Chinese investors are using empty residential real estate as a “store of value,” much like gold.  It doesn’t produce anything, but it’s a convenient place to stash their cash.  That’s why the rise in China’s property prices has proven so persistent (and resistant to “popping”) despite the self-evident glut of unused high-end housing that Ordos so vividly illustrates.

“So what’s the big deal?” I’m used to hearing.  “If there’s no leverage, then there’s no bubble.”  But as I pointed out in my earlier post on “Leverage and China’s Property Market,” this is misconception (this was also the essence of a spirited exchange I had on CCTV News’ Dialogue program Tuesday night, I’ll post the link here when it’s up).  Leverage (borrowing to invest) can help fuel a bubble, and it can amplify the damage caused by its ultimate collapse, but leverage is not a necessary condition for a bubble to form.  In some of the most famous bubbles in history — the Tulip Craze, the South Sea Bubble, and the Dot-Com Bubble — leverage played little role, and people mainly invested and lost their own money.  Demand for empty residential units as a store of value (like gold) is real demand, but it’s also a historical aberration.  It’s based on a highly unstable set of unique circumstances, including (1) limited investment alternatives for Chinese savers, (2) a limited track record, since China converted to private home ownership in the early 1990s, in which investors have never really seen a sustained downturn, and (3) minimal holding costs for idle property, including the absence of any annual property tax.  If any of these factors were to change, that source of demand could evaporate, either quickly or over time.  (This is why I always try to draw the careful distinction between high real estate prices being persistent, which they are, and sustainable, which I believe they are not.) 

In the meantime, demand for housing as a pure investment vehicle competes with demand for housing as a human need, driving up prices for people who actually want a place to live, and skewing the development market towards the very high end, which most Chinese can’t afford.  So despite the two trends that China’s real estate bulls often point to — urbanization and rising incomes — which are quite real, there’s still a major overhang in the market.  If you took all these empty stockpiled apartments, which are being held off the market, and had to fill them with end users, the market clearing price would be far below what people think these units are worth.  That’s a bubble.  And as I’ve also pointed out, China’s banking system does, in fact, have significant exposure to property prices, both in lending for commercial property development and in regular business lending predicated on real estate as collateral.  It may not look the same as in the West, but the exposure is there, and it’s all the more serious for being less apparent.

One of the most interesting elements of Lu’s report, to my mind, is the rationale local officials give for why building an empty new Ordos is better than the alternative.  Prior to building the new city, the region’s thiving “coal bosses” were taking their newfound fortunes and buying up properties in Beijing.  “By selling new properties to locals,” Lu writes, “Ordos retains capital that might otherwise flow to Beijing for much more expensive properties there.”  Fair enough.  If investors are going to use their cash to stockpile empty apartments, you might as well channel it into the local economy and employment, rather than sending it somewhere else.  But the same could be said of building the Pyramids.  Whether it’s a sustainable or productive use of resources is another matter.  From an economy-wide perspective, the essential question to ask in all of this is, is wealth being created?  Or are resources merely being consumed in order to represent (store) wealth?

Along these lines, there was an intriguing report on CCTV News’ BizAsia program this morning, about how Chinese investors scared off by uncertainty over real estate prices are now rechanneling their money into gold, causing a surge in gold buying here in China.  I don’t have a link to the report or the specific data it cited (I’ll post it as soon as they put it up on their site) but you can watch a short clip of me commenting on the report here.  Those who are interested can also check out my interviews from this Tuesday on China’s latest inflation figures, whether the Chinese economy is in danger of overheating, and whether China is having any success at reining in runaway lending.  From today’s show, you can also watch my predictions for the upcoming Strategic and Economic Dialogue (S&ED) between China and the U.S. in Beijing later this month.

I do want to say kudos to Ting Lu, though, for some top-notch research.  I may differ in my conclusions, but his work is the kind of useful analysis that really contributes substance to the debate.

9 Comments leave one →
  1. Roel permalink
    May 14, 2010 5:47 pm

    Seems like the first link is behind some form of pay wall but without any indication of how to actually pay. Is there another location for this document?

    • prchovanec permalink*
      May 14, 2010 11:31 pm

      Hmmm … I’m not a paying subscriber and I can access it. You might also try typing in this link:

      • Roel permalink
        May 19, 2010 12:44 am

        I get

        “This report can only be accessed through its… link. If you are a BofAML client and do not have this link, please contact your BofAML Sales Representative for access.”

        when using the first link, and

        “The document URL is not valid.”

        when using the second. It’s probably got to do with cookies that are set when visiting an earlier page on the site. Ah well.

  2. Bob_in_MA permalink
    May 14, 2010 11:40 pm


    Great post, as it the earlier one on leverage in China’s housing market.

    The 50% down payment sounds impressive, unless it was a change from 100%. That is a huge increase in leverage.

    “Leon” posted this on Michael Pettis’ blog:

    “The loan to value ratio has been between 10-20% from 2005 to 2008, it had increased to 46% in 2009 and further surged to 76% in 1Q10. (I used the incremental increase in mortgage loans from PBoC report and value of commercial residential transacted data from NBS. I further verified those numbers with sellside banking / property analysts from DB, ML and GS, but to my surprise this change in dynamics is largely unknown to those analysts.) I suspect the surge in loan in April further increases this leverage ratio. ”

  3. J.C. permalink
    May 15, 2010 5:38 am


    After reading all the posts of 2010 and a few sporadic posts from earlier, it seems clear that you believe there is some type of bubble forming in China centered around real estate. Given that opinion, some type of correction seems inevitable. What would such a correction mean for the United States economy? I’ve read that, in such a case, china would use their stockpile of U.S. Treasuries to bail out developers. What does that mean for future U.S. lending/borrowing?

  4. Karen permalink
    May 15, 2010 2:52 pm

    I wonder how all those cash buyers acquired their cash. The way they seem to be throwing it around suggests it is easy money, not hard-earned, but of course that’s just conjecture.

    How many of them are aware that they are participating in a Ponzi scheme? Do they seriously expect to be able to sit on their units until they want or need their cash, or are they all anxiously watching the sales statistics to see when they should run for the exits?

    It’s weirdly comforting to think that Americans aren’t alone in our amazing ability to delude ourselves…

  5. Jay permalink
    May 15, 2010 9:12 pm

    You are right, Lu is wrong.

    RMB is overvalued.

  6. Jay permalink
    May 16, 2010 2:14 am

    When you buy an apartment to live, it’s a utility.

    When you buy an apartment to rent out, it’s a bond investment.

    When you buy an apartment and let it sit empty hoping for appreciation, it’s a stock investment.

    If it’s a utility, no matter how high the price is, there is no bubble, because the demand is real. If it’s a bond investment, there is no bubble, because there is no resource wasted. When apartments become a stock like investment, you know things are not right, 50% margin is very high for stocks. People normally don’t buy stocks on margin, even that, stock bubble will burst at due time.

    To those people who argue there is no real estate bubble in China, I say they don’t even have common sense or they are insane.


  1. Build it and they will come. Or perhaps not. –

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