Ghost town, Inner Mongolia: Inside China's empty cities

December 21, 2010: 7:45 AM ET

They're building it, but will they come? Why China's real estate boom looks so troubling from the outside.

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Ordos, Inner Mongolia

Are China's banking and real estate sectors in a bubble, destined for collapse and an equity wipeout of the first order? Or is the country's government proving to be a far more measured and steadier hand at the till than their discredited Western counterparts? It's an argument of the never-the-twain-shall-meet sort, which is all the more ironic considering the Kipling was speaking of the differences between East and West when he coined the term.

Last week, the naysayers were handed quite a piece of convincing evidence in the form of a research report from Hong Kong-based outfit Forensic Asia entitled China: Ghost Cities. Gillem Tulloch, the analyst who wrote it, did some shoe-leather (of the virtual web surfing sort) research to compile a list of seven ghost cities in China that should strike fear into the heart of anyone with exposure to the country's financial sector.

We're not talking ghost towns of the old West type, the ones that time passed by and left as mere intersections with a saloon and a hardware store. We're talking massive cities that the Chinese government is in the process of building in the hopes that people will come. But the people have not come. Yet the billions are in the process of being spent.

Yunan University Campus, Yunnan, Changgong

Back to the shoe-leather point: Tulloch came up with his damning evidence not by trying to crack the notoriously secretive country's data keepers, but by pulling up Google (GOOG) Earth and taking a look around. He saw the empty streets of Ordos in Inner Mongolia. He pinpointed the forlorn $19 billion Zhengzhou New District in Henan, a place with plans for fifteen yet-to-be-inaugurated universities. And he saw Erenhot, Xilin Gol, in Inner Mongolia, otherwise known as the middle of the desert. As Tulloch dryly points out: this is not exactly the first place that comes to mind to locate a luxury hotel. It's spooky, just as you would suspect a bunch of ghost towns to be.

And it's not just China. We've got the likes of this in Las Vegas. And, as the New York Times pointed out late last week, Spain has 'em too. Ghost towns are apparently very "in" these days. Or were a few years ago.

Xinyang, Henan

I caught up with Tulloch to ask him what it all meant. He started soberly: "I think people have a feeling there is too much capacity in the country's real estate sector." But quickly became more forthright: "If you want to ruin a banking sector, you would do three things. First, grow its loan book too quickly. Second, have the government direct its lending. Third, have some of that lending go to the government itself. China is in the process of doing all three. Did I mention that the Chinese government pays about 200 basis points less than most creditors and it has a history of a high percentage of non-performing loans? They have mispriced capital in a most egregious way, and have created a bubble."

But maybe they're creating art in the process. In February, Foreign Policy reported on how one Chinese interpreter makes it all work -- he sings alone in an empty hotel room in an empty city, finding solace in online karaoke. It might not be enough.

Tulloch and his partner, Dr. Jim Walker, the longtime chief economist at regional brokerage powerhouse CLSA, have created a subscription-based research business at Forensic Asia that they hope will enlighten in ways beyond the usual dregs that come out of sell-side research operations. Enlighten and terrify, more like it. Or excite: well-known short-seller and increasingly vocal China bear Jim Chanos is a fan – he's the one who alerted most of the press to the report in the first place. Says he: China is on "an economic treadmill to hell." No splitting hairs on that one.

(An unrelated insight from Tulloch: he is no fan of the Asian Water Sector, particularly the Chinese companies participating therein. He sees phantom profits being reported in the place of real-world losses. Considering that phenomenon in the context of Western banks, perhaps it's not so unrelated after all...)

Erenhot, Xilin Gol, Inner Mongolia

Of course, you can find the opposite side of this argument without searching too hard. Or at least a more measured response to the images of empty cities the size of Washington DC sprouting all over the middle of Chinese nowhere. CLSA's China specialist, Andy Rothman decrees that, "There is no national housing bubble." Blackstone's (BX) Byron Wien agrees. But that's the beauty of opinions—we're each entitled to our own. Tulloch delivers his quite succinctly: "Remain short Chinese financials." Ignore his research at your peril.

Also on Fortune.com:

China's labor market: Valuable asset or economic albatross?

China's 'death grip' on the dollar

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About This Author
Duff McDonald
Duff McDonald
Contributing Editor, Fortune

Duff McDonald is a contributing editor at Fortune. He has also written for New York, Vanity Fair, Condé Nast Portfolio, GQ, WIRED, Time, Newsweek, and others. In 2004, he was the recipient of two Canadian National Magazine Awards -- best business story (gold) and best investigative reporting (silver) -- for "Conrad's Fall" in National Post Business. Last Man Standing, his biography of Jamie Dimon, chairman and CEO of JPMorgan Chase, was published by Simon & Schuster in October 2009. He is also the co-author, with Owen Burke, of The CEO, a satire.

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