Ordos

"It is more than anywhere the symbol of the Chinese Dream with all its challenges and contradictions, an Orwellian vision of a bright future caught up by a less flamboyant reality."

It was a relatively calm overnight session in which European stocks wobbled modestly, Japan was up, China was down following its weakest fixing since 2011 as the PBOC continues to aggressively devalue since the SDR inclusion (stoking concerns capital outflows are once again surging), EM stocks stocks were weak and the dollar was unchanged ahead of today's retail sales data and next week's Fed meeting, and then suddenly everything snapped.

Having government control over the levers of the economy can have advantages. For example, by taking prompt action, the Chinese government was able to pull the economy out of the recession remarkably fast, basically by fire-housing the stimulus package that was equivalent to 12% GDP. That’s the advantage. The only problem is that these kinds of short-term advantages come with long-term, painful consequences.

Who can forget China's ghost city of Ordos: back in late 2009, when the hollow shell behind China's torrid growth was first revealed to the world, the city near China's Mongolia border was cooler talk for weeks. Fast forward five years later, and Ordos is all but forgotten, having been eclipsed by a veritable army of much bigger "ghosts" that make up the "ghost town network" - a list of cities created by the China Investment Network, a business newspaper in Beijing, to determine which cities were the most ghostly. Below we present the 10 biggest ones.

Nowhere is China's historic misallocation of capital (resulting from a pace of credit creation that makes even the most fervent Keynesian western central banker green with envy) more evident and tangible, than in videos showing the tumbleweeds floating down the main streets of its ghost cities. We did that first in 2009, then followed up two years later only to find nothing has changed. Today, on yet another "two years later" anniversary, we go back to the scene of the excess capacity crime, to find out if thing may have finally normalized. For that we follow SBS' Adrian Brown who back in 2011 did an extensive report on what were some of the then unknown ghost cities dispersed across the mainland. What we find is that not only is the overcapacity problem nowhere close to being resolved, but that 20 new "ghost" cities are taking shape in this year alone.

Overnight news began in China where the CPI came in 2.7% versus consensus of 2.5% although PPI continues to decline at a faster pace than expected (-2.7% v -2.6%). While nobody believes the actual print, that the PBOC is telegraphing an inflationary "leak" shows its willingness to continue with pro-tightening measures which is why despite an Alcoa "beat", the SHCOMP was up only 0.37%. Elsewhere in China, Bloomberg news quoting Xinhua said that some district governments of Ordos of Inner Mongolia is struggling with finances and had to borrow money from companies to pay salaries of municipal employees. Ordos is the infamous "ghost town" spurred by the mining boom in Inner Mongolia. The Bloomberg article noted that Ordos local government entities have CNY240bn of debt versus CNY37.5 billion of revenue last year.  And while the Alcoa "beat", helped handily by a hilariously "tapered" consensus into reporting day, did little for China it was the catalyst that pushed global stocks higher worldwide.

It has been four years since we first introduced the non-believing world to China's ghost cities. Two years later, we revisited to check on the widescale immigration that was expected to occur into these salubrious suburbs. Alas, another epic Keynesian fail as we so delicately described the 'if we build it, they will come' mentality. Now, four years after the news of the Chinese real estate bubble began to break on tin-foil hat-wearing blogs, the mainstream media (to wit, Sixty Minutes) have gone in depth - taking a wonderfully eery trip through these ghost cicties explaining the growing (and in some places popping) bubble in Chinese real estate markets. The incredulous host concludes this chilling saga, "Meanwhile, people who can afford it are still buying as much real estate as they can... potential buyers crowding buses to see new construction and new owners line up to register their new apts... Like us in our bubble, they just don't believe the good times will ever end." It's all make-believe -- non-existent supply for non existent demand.

From a valuation perspective, Chinese equities do not, at first glance, look to be a likely candidate for trouble. The PE ratios are either 12 or 15 times on MSCI China, depending on whether you include financials or not, and do not scream 'bubble'. And yet, China has been a source of worry for GMO over the past three years and continues to be one. China scares them because it looks like a bubble economy. Understanding these kinds of bubbles is important because they represent a situation in which standard valuation methodologies may fail. Just as financial stocks gave a false signal of cheapness before the GFC because the credit bubble pushed their earnings well above sustainable levels and masked the risks they were taking, so some valuation models may fail in the face of the credit, real estate, and general fixed asset investment boom in China, since it has gone on long enough to warp the models' estimation of what "normal" is. Of course, every credit bubble involves a widening divergence between perception and reality. China's case is not fundamentally different. In GMO's extensive discussion below, they have documented rapid credit growth against the background of a nationwide property bubble, the worst of Asian crony lending practices, and the appearance of a voracious and unstable shadow banking system. "Bad" credit booms generally end in banking crises and are followed by periods of lackluster economic growth. China appears to be heading in this direction.

Better late than never. All you need to read.