Chinas Housing Bubble - Case Study Example

Name : xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Tutor :xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Title : China’s Housing Bubble Institution : xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Date :xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx @ 2012 China’s Housing Bubble China has a property bubble whose effects would be disastrous to its own economy and that of the Globe (Youqin, 2004, 50). Many experts think that China’s housing bubble is a delicate one that can burst any time. Kenneth Rapoza also writes about this Bubble. This essay will discuss the economic effects of the China’s housing bubble. It will also discuss two articles written by Kenneth Rapoza. The essay will therefore analyze how the issues discussed in the second article “China’s non-bubble housing bubble’, resulted from the issues discussed in the second article “How China’s Housing Bubble is Different.” Economic Dangers Posed by China’s Housing Situation The property bubble in China has been rated as carrying a bigger danger than the asset price bubble. The bubble is caused by over investing in capital expenditure and building an economy that is led by exports. A boom in capital investments has created a demand that is not easy to sustain. China has a lot of capital investments and its boom depends on this. Exports support capital investments a lot (Zheng and Kahn 2008, 746).A deterioration in exports means the economy can be badly affected. Capital investment and exports can both go down and this may result in reduced demand. When regional banks use bank lending instead of tax revenue for financing their public works projects, they have no returns on investment. This makes it hard for them to service the debts hence banks are left with huge bad loans. Speculating investments in real estate are also becoming bad with the bursting of the asset price bubble. Banks stand to suffer very badly if the central bank does not support its subordinates in the region banks stand to suffer because these subordinates are the ones that can create a massive deficit in the budget. In tier 2 and tier 3 cities, the prices of property are not very much costly. However, one cannot rule out the possibility that the prices of property can be very much inflated in the coming few years. If this happens then there could be a crash (Wing, Ming and Sachs, 2012, 78). Going back to history, between 1993 and 1994 China went through a very bad real estate melt down and recession in growth. There was a 40% drop in property prices in big cities and the growth in the GDP of the private sector fell by 3%. There was a rise in non-performing loans up to 30% of the total assets of the banking sector. The government took 7 years to rectify the situation. This is an indication that is another asset bubble bursting can be experienced; the banking sector would be damaged very severely. Based on historical facts, credit inflation results in asset bubbles and when the bubble bursts there is always a crisis in banking and contraction in credit. In the case of China, big companies owned by the state rely on bank credit. A credit crunch can easily choke off the growth of these companies within a very short time. However, the situation today is totally different from that which was experienced in the 1990s because China today has a lot of reserves (Wang 2001, 625). The country also has big surplus on its current account. In the 90s the current account had a deficit and the reserves were very little. Because of this, a melt down in real estate resulted in the collapse of the currency of China between 1992and 1993. Today, China has massive resources to recapitalize its banking systems and for economic stimulus purposes. It is true that there would be a severe effect of a bursting bubble but this would be countered by spending in the public sector (Wing, Ming and Sachs, 2012, 35). If the housing bubble bursts, the effect would also spill into commodity prices. Commodity producers and markets in Canada, Australia and Latin America would definitely be dealt a big blow. The effect would also hit many Asian countries especially Japan. Japan has had no domestic spending in the near past and the growth in its economy has been hugely supported by exports going to China. If the China housing bubble bursts, then the performance of the market asset and economic performance in Japan would be hit hard (Youqin, 2004, pp. 46). The world would also suffer from China’s predicaments. If there is a growth recession in China, the global economy would suffer because there would be a surge in global savings excesses and a deficiency in the global aggregate demand would be experienced. A drop in stocks and bond yields would be inevitable with investors going through very dark financial periods. Rapoza’s issues in article 1 and 2 Rapoza in “How China’s housing bubble is different’ discusses issues that seem to be contributory factors to the issues he discusses in the second article ‘China’s non-bubble housing bubble.’ Rapoza’s discussion focuses majorly on the issues that resulted in the housing boom in China. In the first article he says that high population growth and the increase of the people in the wealthy bracket have led to the housing bubble. The rich people are growing richer as the poor grow poorer (Wang, 2001, 628). The expansion of the urban middle class and the purchase of big office spaces by big investment banks lead to high property prices. This increase in the purchase of property especially in the second and third tier cities results in the continuous rise in housing prices. According to Rapoza, the sharp rise in housing prices prompted the government to introduce certain policy measures that can slow down inflation in real estate. Such measures are among others the increase of interest rates, the increase of requirements for down payment, direct restrictions on home purchases, price controls especially in Shaghai and Beijing and imposing a tax on real estate (Qingyuan, 2011, 37). There is still a vey high demand for commercial property and this demand is rising by the day. The high population of China and the growth of the economy have made it so hard for the government to control property prices. The government’s efforts to control lending have been in vain (Zheng & Kahn 2008, 750). The issues discussed in the second article were also caused by the government’s five year program which has had effects on household consumption and capital formation. The five year program has often resulted in an increase in capital economy. This in turn has contributed to the issues affecting the housing sector. It brought about economic growth which directly results in increased purchases in real estate hence the rising property prices. Consequently, cities such as Shanghai, Beijing Taiwan and Hong Kong are becoming too expensive for ordinary Chinese and the middle class is being forced to leave and settle on the outskirts or go to other smaller cities all together (Wang, 2001, pp. 630). The problem of housing in the country continuous to be what it is today because the government has failed to take serious long term steps to solve the problem. The government focuses so much on big banks and enterprises and this contributes much to issues that Rapoza points out. The macro measures that have been put in place do not provide permanent solutions to the existing problems. The government tend to fail in the process of imposing reasonable taxes and high interest rates on real estate property. Lack of these two contributes to the increase in purchase of space and houses by keeping spectators away and reducing the money flowing into real estate. The monetary policy of China is unrealistic and this has maintained the value of the Yuan at a low rate hence the low interest rates on property (Wing, Ming and Sachs 2012, 45). Although Rapoza may not have mentioned this, it could make the housing bubble worse. The banking system in China is composed of vehicles for government finance such as trust products and wealth management products. This system contributes immensely to the existence of the property bubble and it may even worsen it in the future. The system also fuels corruption since money is hidden in property (Qingyuan, 2011, 56). Conclusion In conclusion, this essay has discussed the economic dangers that the housing situation in China poses. It also has a discussion on how the issues discussed in the first article resulted in the issues discussed in the second article. Finally, an issue that could worsen the housing bubble has been elaborated. The housing bubble in China can result in disastrous effects to the economy of China, the whole of Asia and that of the whole globe. Commodity prices in China and outside would be adversely affected and the rest of the world would suffer from a surge in global savings excesses and a deficiency in the global aggregate demand. The issues discussed in Rapoza’s second article resulted from high population growth, high economic growth resulting from increased capital investment and the government’s introduction of policy measures. The five year program by the government and its reluctance to raise the interest rates and taxes on property has a negative effect. This is because of China’s unrealistic monetary policy. Focusing on big banks and enterprises by government also exacerbates the problem. The banking system in China is composed of vehicles for government finance such as trust products and wealth management products. This system contributes immensely to the existence of the property bubble. This system also fuels corruption. Bibliography Qingyuan Z. 2011. Applied Economics, Business and Development: International Symposium. Springer. Wang, Y.P. (2001). “Urban Housing Reform and Finance in China: A Case Study of Beijing.”Urban Affairs Review 36(5) pp. 620-645. Wing W., Ming L., Sachs, J.D. 2012. A new Economic Growth Engine for China: Escaping the Middle Income Trap by Not Doing More of the same. World Scientific. Youqin, H. (2004). “Housing Markets, Government Behaviors, and Housing Choice: A Case Study of Three Cities in China.” Environment and Planning, Vol. 36, pp. 45-68. Zheng S, Kahn M.E 2008. Land and residential property markets in a booming economy: New evidence from Beijing, Journal of Urban Economics 63, 743-757. Read More