The City as The Ultimate Bubble

by Misha Lepetic

Financial markets have a very safe way of predicting the future. They cause it.
George Soros, Der Spiegel

Purpose-built cities are nothing new, especially when an authoritarian government seeks to establish a new capital far from the distractions and chaos of the commercial capital. Recent and well-known examples include Abuja, Naypyidaw and Brasilia, but one can go further back into history to find others: St Petersburg and Washington, D.C. are principal examples from the 18th century, and Ayutthaya was established in 1350 by King U Thong and remained the capital of the Kingdom of Siam until it was razed by the Burmese Army in 1767. Nature has been equally adept at forcing the hand of governments, however: Belmopan, the current capital of Belize, was built following 1961’s Hurricane Hattie, which nearly leveled Belize City (then the capital of British Honduras, if we are to be perfectly accurate in these matters).

Small_temple_of_the_aten_at_akhetaten_amarna_egypt_photo_wiki Unilaterally decreeing the establishment of a city is not without its risks, of course. The urban form acquires its robustness through a complex, dynamic and unpredictable confluence of people engaging in economic, military and cultural activity. Another crucial ingredient is any city’s contextual relationship to the rest of the world, usually represented by access to either resources or control of valuable trade routes. Thus it is not surprising to learn of the fate of Akhetaten, hardly outlived by its founder, the Pharaoh Akhenaten, father of Tutankhamen. Now known as Amarna, it was founded by Akhenaten’s vision of a society unified through the worship of a single cult, that of the Sun or the Aten. However, 1353 BC proved to be a bit early for the monotheistic worldview, and following Akhenaten’s death both the city and his theological innovation were abandoned within a few years.

More recently, the purpose-built city has served another function: that of goosing GDP. It is well known that the Chinese government has thrown itself wholesale into the business of city-building. Depending on who is counting, there are upwards of dozens of metropolises designed to accommodate anywhere from 100,000 to millions of new inhabitants. While I have already written about at the over-reach of urban planning in attempting to design entire cities as effective places for people to live, in this case it is much more interesting to look at why these cities are being built in the first place.

The stated reasons are all old chestnuts that have been trotted out time and again: alleviation of rural poverty; maintenance of social stability; demand for housing created by the unstoppable tide of rural-urban migration, and so on.

At first blush, this may seem to be a reasonable affair. Investment in infrastructure, generally speaking, has been deployed by governments seeking to create stimulus in lean times, such as the Works Progress Administration, or during times of plenty, such as the development of the Interstate Highway system. One of the principal tools deployed by the Japanese government following the implosion of its economy in the 1990s has been the relentless updating of its infrastructural backbone. The argument here is that not only does infrastructure spending create jobs needed to design, develop and maintain this infrastructure, but also leaves behind tangible public goods that are foundations for new industries and marketplaces. Could we apply the argument to entire cities? And what kind of cities does this produce?


The Chinese Communist Party has maintained the importance of growth as the most essential factor in Chinese society’s integrity. In fact, the Party’s ability to deliver that growth in an orderly fashion has become its self-appointed raison d’etre. And these growth numbers are truly phenomenal: the current rate of about 8-9% per year implies a doubling of China’s GDP every 9-10 years. But one ought to be wary of the gathering consensus that “this time is different” – that the Chinese government has managed to safely and effectively harness the nuclear chain reaction of capital’s most powerful features. A look below the surface, at how in fact these numbers are achieved, and more importantly, the physical consequences of that achievement, suggests that things – still – are not all that different.

For example, one would be forgiven in thinking that a city ought to be built de novo in order to address a pressing need: suddenly a lot of people need to move to a place and live and work in proximity to one another. In the past, for example, a natural resource discovery may precipitate the seemingly spontaneous generation of a mining town, even if that town is artificial and temporary, ie, unable to transcend the circumstances of its founding. The establishment of a new port, or in the case of Shenzhen, a pioneering free trade zone, is more durable by its very nature – the circumstances of trade and industry might change, but the initial attractions of the site or its special administrative status remain. These cities continue to possess the relevant context in which they can retrofit themselves for future economic and social activity. In fact, this is perhaps the most common trait of long-established cities – their seemingly endless capacity for reinvention.

In the case of many of the cities being constructed in China right now, the motivating factor is oftentimes entirely removed from the idea of what a city is supposed to accomplish. Rather, the imperative for growth is what is driving both government spending and private sector activity. In the finest central planning style, the Chinese government sets its growth targets, and these targets then filter down from the regional to municipal level. Officials, whether appointed or elected, receive these targets and are told in no uncertain terms that their careers hang on the balance of their achievement. And there is no more powerful vehicle for this development strategy than to build big – big infrastructure, and now, big cities.

For the reasons discussed above, this seems a pretty good strategy. Hundreds of thousands of constructions jobs are meant to be followed by a similar number of jobs that will be necessary just to make the city run. China is also doing this from a position of economic strength – unlike efforts like the WPA, this is not an initiative designed to pull the country’s economy from a lower, sub-optimal Nash equilibrium. As is fitting for a country with serious hard currency reserves, a currency that exchanges in a narrow band in relation to its partners, and possessed of a low cost of labour, it is seemingly easy to put this whole scheme into fruitful motion.


What do we really know about the housing situation in China, anyway? Analysts have recently bandied about a number of 64 million empty apartments in China at the present moment. What does this even mean? Measuring anything in China has always been difficult (for example, Western observers have long had to measure electricity production as a proxy for overall industrial activity), but one might be surprised to learn that there is

no clear picture of the whole [Chinese] housing market, because there has been no national housing census since 1985. Besides, management of housing programs can only be traced on the Internet back to 2004 and records have been kept in different departments. So information on houses bought earlier is often incomplete.

Zhengzhou-new-district-residential-towers-empty If we are to take this as a legitimate data point, then what guarantee is there that there will be anyone to show up in these cities? One may reasonably assume that the current population of China is not in fact homeless. More anecdotal evidence shows that in fact these cities are in fact, rather empty. In the case of Ordos, a lonely toy seller makes a sale every few days – in an empty mall designed to accommodate 1500 vendors. The city around it has not fared much better, and yet a quick trip down the pristine highway to the original conurbation that Ordos was meant to replace shows us the messy hustle and bustle of any normal city. It’s just that no one can seem to find a reason to move to Ordos. Perhaps it has something to do with the fact that there is no one there to begin with.

That the Chinese have shown themselves as enthusiastic bubble blowers is beyond dispute (salt, anyone?) and there are plenty examples of these Martin Dressler-esque schemes getting financing and then going bankrupt or just being abandoned outright, Wonderland perhaps being the most surreal. But it should also be noted that the media have developed a tendency to deliver these stories with a certain degree of Schadenfreude. Unfortunately this hints at a certain laziness on the part of media and its consumers, for it is all to easy to heap scorn on this kind of hubris, and watch the time-lapse footage of these cities slowly fall into ruin and are reclaimed by deserts and jungle. There must be deeper lessons for us to absorb.


These lessons have, in fact, been pointed out by commentators in the West – a case in point are hedge fund managers Hugh Hendry and Jim Chanos, who have bet extravagantly against the Chinese housing market. Even the above traits of fiscal stability and economic robustness don’t allow a country to grow cities as if they were so many Sea Monkeys. The money must come from somewhere.

If we are to begin with an anecdote, consider the case of billionaire real-estate developer Jin Libin, who, last April,

set himself on fire to escape his creditors. His method of dealing with the situation was disturbing enough, but the structure of his debt was equally shocking. Investigators found that his billion renminbi business owed banks only 150 million RMB, but owed individual creditors and informal banks Rmb1.23bn.

When people talk about the Chinese bubble, what they are in fact talking about is the consequences of a shadow banking system’s unbridled gallop into ever-riskier ventures. Sound familiar? In the same way that overly lax monetary policy in the United States led to the financial system’s crazed pursuit of yield, China’s government has unwittingly produced a similar beast. Here the response is the opposite – with interest rates high and getting higher, the formal banking sector is disincentivized from making loans that will continue to heat up the economy and encourage speculative behaviour. Nevertheless, the growth targets persist, and the perverse result is that developers like Jin Libin resort to the wholly unregulated informal sector – where loans can be made by handshake, and interest rates are high enough (20%-30%) that there isn’t much reason for due diligence on either side. As long as the music is playing, the Chinese are dancing.

But how big is this hole that the Chinese seem to be digging for themselves? According to a recent New York Times article,

As municipal projects play out across China, spending on so-called fixed-asset investment — a crucial measure of building that is heavily weighted toward government and real estate projects — is now equal to nearly 70 percent of the nation’s gross domestic product. It is a ratio that no other large nation has approached in modern times. Even Japan, at the peak of its building boom in the 1980s, reached only about 35 percent, and the figure has hovered around 20 percent for decades in the United States.

Sizzling-is-an-understatement-for-some-chinese-property-markets-home-prices-in-haikou-have-jumped-54-in-the-past-year That is one hell of a build-out. And what is funding it? Familiar-sounding accounting gimmickry like special purpose vehicles, off-balance sheet entities, and bonds issued based on wildly overvalued municipal land. A shining example is taken from urban development in Loudi, a minor city of ‘only’ 4 million: “Local governments set up more than 10,000 so-called financing vehicles in the past decade to get around laws prohibiting them from taking direct loans. One third of them don’t have cash flow to service their loans, China’s banking regulator says. The similarities with special purpose vehicles in the U.S. hiding toxic repackaged mortgages from banks’ balance sheets are increasing.”

Not only that – to return to the case of Ordos, one might be surprised to hear that there are a fair number of properties already sold. Squaring this with the abject lack of people, one realizes that the apartments have been bought as investments, even though no one can seem to afford to live there. An empty city owned by absentee landlords? At least Miami has decent nightlife.

Indeed, ultimately the lessons are the same, as Barry Ritholtz argues:

…the typical investing bubble leaves behind something of value. Whether it was thousands of miles of railroad tracks in the 19th century or thousands of miles of fiber-optic cables in the 1990s, usable infrastructure survives the bubble. Assets get scooped up out of bankruptcy for pennies on the dollar. Eventually, all of this overinvestment in the bubble du jour becomes a productive part of the economy. All that cable laid by Global Crossing and Metromedia Fiber and other bankrupt firms? Today, it is the bandwidth infrastructure that supports Google Maps, Netflix streaming video and Twitter.

Compare that with what gets left behind after a credit bubble bursts: No physical infrastructure, innovations or research breakthroughs; just soul-crushing, economy-sapping debt. And not just regular old balance-sheet obligations, but huge piles of counterproductive consumer and government liabilities.

It looks like the Chinese will wind up with plenty of both bubbles on their hands, but even with this current dilemma, they may come out ahead. At the very least, they should have their choice of where to live.