China is in the grips of a rapidly expanding property bubble. Prices are up 12.5 percent in the first quarter compared with a year earlier. Shanghai's property market bubble is more severe. The increase was 19 percent in the first quarter year-on-year after a 26 percent rise in the price of homes sold last year and average price increases of about 90 percent since 2000.
Beijing has announced a number of initiatives to dampen the rising prices of real estate. Among these are taxes on property sales. As well, land left unused for more than a year will be taxed, and sites unused for more than two years could face a revocation of title to prevent property hoarding.
For their part, authorities in Shanghai imposed a 5.5 percent capital-gains tax on apartments sold more than once within a year and have proposed increased taxes on residential maintenance fees. Meanwhile, banks are beginning to require down payments of up to 50 percent on selected mortgages.
Instead of a concerted effort to stem the basic cause of rising prices, the targeting of speculators in certain cities is misguided and will be fruitless. Indeed, the proposed policy moves reveal a fundamental ignorance of the nature and cause of speculative excess. Part of the confusion is over symptoms and causes.
A careful consideration of the over-valuation of urban property in China reveals that Beijing's policies are the central cause. Among the policy mistakes are those that support export-led growth, especially the peg of the yuan against the US dollar.
Some foreign investors have bought property in hopes of receiving capital gains from a revaluation of the yuan. Allowing the yuan to revalue would end the inflow of money to speculating on property prices. In all events, it is correct to view the property sector as a potential source of economic and political instability. It is not just a matter of higher property prices generating discontent among poorer residents priced out of the market.
Speculative purchases of property have contributed to pressures on important commodities like steel and cement. These pressures are raising the cost of keeping the yuan peg.
It turns out that the real problem will be when the bubble blows up in the face of those that bought in and are wiped out. And China's experience with the market economy has extended private ownership of homes and apartments to a new and growing middle class.
The political ramifications of a bursting property bubble that depletes the fortunes of middle-class Chinese could be immense. At the same time, enterprises employing construction workers or producing construction materials, as well as home appliance makers, will begin to shed jobs. This could put a lot of angry people onto the streets.
Sharp declines in property values could also push the weak banking system over the edge, taking what is left of the value of household savings with them. Perhaps anticipating this problem, banks have been allowed to increase mortgage interest rates along with large deposits from some house buyers.
A deflated bubble would increase bad loans held by state-owned banks -- which began making mortgage loans in 1998 when citizens were granted the right to buy and sell homes. Although household borrowing accounts for about 15 percent of the US$2.3 trillion in loans outstanding last year, more than half of total lending involves property as collateral.
The massive increase in export sales has forced the central bank to try to sterilize the effect of the inflow of dollars by issuing debt. But interest rates were kept relatively low to make holding the yuan less attractive in support of the dollar peg.
Meanwhile, the central government has been running an increasingly large deficit while allowing state-owned enterprises to engage in a massive expansion of capital expenditure. The net effect has been for debt to rise while pricing pressures increase anyway.
With low interest rates enticing both property developers and home buyers, it is no surprise that a real-estate bubble has emerged. Instead of demonizing speculators for increasing property prices, blame should be directed toward Beijing for allowing the economy to be flooded with credit and for its own higher spending.
Without excessive liquidity and easy credit, rising prices in one sector of the economy must be offset by price declines in other sectors. This clearly has not happened in China.
In sum, asset price speculation that leads to bubbles arises from conditions created by policy choices of politicians or central bankers, or both. Excessive speculation in property markets is supported by fiscal deficits and rapid credit expansion by central bankers.
China's export-led growth policy and its doomed dollar peg are the primary source of inflated property prices. The bust after this boom may have a devastating political effect since disaffected citizens cannot demand a change in regime. Any attempts to "turn out the rascals" that brought on the coming crash may be met with force not seen since 1989 in Tiananmen Square.
Christopher Lingle is visiting professor of economics at Universidad Francisco Marroquin in Guatemala.
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