Too Much, Too Soon? — page 3

The same scenario of too much, too soon applies to a range of commodities. Walk through one of China's biggest steel producers, Anyang Iron & Steel. As cauldrons the size of railroad cars carry red-hot slag to rolling machines, the company's vice chairman, Wu Changxun, points outside the factory to a dirt expanse as big as several football fields. Workers are erecting a new foundry that will more than double the plant's output. It's part of the 50 million tons in increased capacity expected nationwide by 2005—enough to equal China's surging imports. "Banks are offering us loans even without our asking," says Wu. That money will have to be repaid—letting extra capacity sit idle is no option. China's demand for steel is so strong that imports have doubled over the past two years, but if the economy cools down and demand drops, "there's a distinct possibility [Chinese steelmakers] will spew out steel and crash the world market," says Cameron Hunt, senior steel analyst at the London-based Metal Bulletin Research.

The central government's economic-planning body, the State Development and Reform Commission, has for several months pondered ways to rein in expansion of what it calls "overheated industrial sectors," including auto, aluminum and steel. So far, it hasn't announced any changes. The central bank earlier this year ordered lenders to boost their deposit reserves by 1 percentage point to 7%. That was supposed to reduce the money supply and slow down lending, but it appears to have had little effect. The government seems unable to decide if the country's expansion pace is just right—after all, China must generate 12 million-15 million new jobs annually just to keep pace with its population growth—or if dangerous bubbles are forming. In June, for example, the central bank tried to end overbuilding in real estate by curtailing mortgages for homes not yet constructed. Two months later, the State Council issued a contradictory policy statement that not only encouraged mortgage lending but also "enhanced loan support" for developers.

As long as the lending taps remain open, developers will keep building. Last year mainland China produced enough new floor space to cover an area the size of Hong Kong—1.2 billion sq m—and new investment this year will rise 25%. Property sales growth, however, has declined by 20% this year. Developers don't seem worried. Vantone, a leading Beijing-based builder, last month put 450 apartments on the market at $200,000 each. Within six hours, it had taken in cash deposits for a quarter of them, and Vantone chairman Feng Lun says he expects the rest to sell within three weeks. Nearly all his buyers took out mortgages even though the developer has yet to finish laying the foundations. Feng chuckles at the idea that banks would try to cool the market by restricting loans. They'll keep lending, he says, because "banks have their own interests in mind."

But banks have grown dangerously exposed to the property market. Beijing alone has more than 3,000 developers, all highly leveraged. Property prices have remained essentially flat across the mainland, with the exceptions of Shanghai and Beijing. At the same time, unsold properties have increased fourfold over the past four years, tallying 230 million sq m last year. Though real estate demand should remain strong—an estimated 10 million Chinese move to the cities every year—for now, supply is simply growing too fast. "The laws of property cycles have not been repealed for China," says Peter Churchouse, who follows property trends in China for Morgan Stanley. "Eventually, the construction companies and the banks that backed them are going to get creamed."

No one knows whether the same scenario will be repeated in other hot sectors, or what the damage might be. China's economy isn't close to collapse. The country will remain the world's premier export power, with the value of what it sells abroad equal to roughly 30% of its total economy (the figure for the U.S., in contrast, is 10-12%). Exports provide China with a major source of income to ride out a contraction at home. China's banks are so flush with the savings of ordinary Chinese that a meltdown is unlikely.

The danger, however, is that the government will let the pressure build until the economy is so saturated with excess goods that banks must cut off credit abruptly, pushing the economy into recession. Economies always look and feel great when credit is easy and factories are coming on-line and new developments are in the works. But at some point, all those washing machines, apartments and automobiles have to be converted back into currency. The question hovering over China's economy now: Are there really enough buyers out there?

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