Moving Too Fast?

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China is the world's largest producer and consumer of televisions

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The same scenario of "too much, too soon" applies to a range of commodities. At Anyang Iron & Steel, one of China's biggest steel producers, the company's vice chairman, Wu Changxun, points to a tremendous dirt expanse outside the factory. Workers are erecting a new foundry there that will more than double the plant's output capacity. It is slated to provide part of the 50 million tons in increased capacity expected nationwide by 2005. "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. If the economy cools down and demand drops, "all that excess steel could hit world markets and send prices into a death spiral," says Brian Levich, senior steel analyst at the London-based Metal Bulletin Research.

The central government has pondered ways to rein in expansion of what it calls "overheated industrial sectors," including autos, aluminum and construction. But it seems unable to decide how fast the economy should expand and so far hasn't announced any significant changes to dampen growth. In June, for example, the central bank tried to end overbuilding by curtailing mortgages for homes not yet constructed. Two months later, the Prime Minister's office issued a contradictory 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. Average real estate prices remained flat last year, despite surging demand. That's because so much new property hit the market, and with investment in residential housing growing 30%, there's lots more to follow. Developers don't seem worried. Vantone Group, a leading Beijing-based builder, recently put 450 apartments on the market at $200,000 each. Within six hours, it had cash deposits for a quarter of them.

But banks have grown dangerously exposed to the property market. Beijing alone has more than 3,000 developers, all highly leveraged. At the same time, unsold properties have increased fourfold over the past four years, totaling 2,475 million sq. ft. in 2002. "The laws of property cycles have not been repealed for China," says Peter Churchouse, who follows property trends in China for Morgan Stanley.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."

With the government still holding many of the strings in China's economy, it is hard to predict when the problems of excess capacity will boil over. While overheated, China's economy isn't close to collapse. Whatever happens, the country will surely remain heavily dependent on exports. Currently the value of what it sells abroad is equal to roughly 30% of its total economy (the figure for the U.S., in contrast, is 10% to 12%). But the pressures are building, and when bomb factories are producing cars financed by an electric-battery company, the future can only be described as highly volatile.