Myths behind the Chinese Property Bubble

    In the previous post, I talked about the housing price bubble in Japan during 1990s and made some statements about the potential reasons behind the housing bubble. In this post, I am very curious about the existence of housing price bubble in China from 2005 to 2012. Firstly, I start with formation and expansion of the property bubble. After that I will talk about the turning point—development of the property industry during 2008 financial crisis, and finally, end up with reflation after the crisis.

• Formation of the property bubble

    At the beginning of 2003, Chinese government listed the real estate property industry as one of the most important industries that drive the development of economics and implemented a lot of policies to encourage investing in the real estate industry. Meantime, the Bank of China (BOC) implemented some monetary policies, (such as low the rate of loans and discount the down payment of purchasing a house) to attract residents’ investment in this industry. The housing bubble emerged initially at that time. However, the housing price during this period of time rose within a reasonable interval until 2005, because the Chinese government realized the rapid increase in housing price and adjusted some policies to limit this increase, they included:

1. Up-regulated the loan rate of purchasing houses (even higher than the original unadjusted one)
2. Canceled some preferential loan policies (e.g. increased the proportion of down payment of a house loan by 10%) 
3. Taxed for second-hand house transactions
4. Enhanced the credit standard investigation of the real estate companies.

    Nevertheless, these polices did not prevent the final expansion of the bubble.

• Expansion of the property bubble

    As many capitals flowed into real property industry in 2006, the housing price started to expand dramatically. The house price tripled from 2006 to 2007, although the Bank of China increased the loan rate 5 times from 5.0% to 7.29% and raised the reserve ratio of commercial banks. Why the housing bubble stubbornly expanded with no regard of any monetary policies? There are few reasons for this substantial expansion:

  

    1. Local government increased land prices dramatically during this period for local government income and a vanity for GDP growth ----> rise the costs of real estate companies ----> raise the price of houses

          2. It is Limited for Chinese investors to get access to foreign investments. Therefore, they invested mainly on domestic properties---->increased the demand of real estate properties.

          3. High inflation rate

     From the China inflation rate chart above, we can observe that from January 2006 to January 2008, the inflation rate in China boomed to a very high level (approximately 9% per year). During this period of time, almost every citizen in China expected that the inflation would maintain next period and this anticipation drove them to invest in the real property to retain the value of their fiat money and, thereby increasing the demand of house even further. 

• Temporary deflation of the property bubble and following recover

We all know that there was a serious financial crisis in 2008 all around world. China did not escape from this crisis, as a result, the bubble in stock market burst in 2008. However, a strange thing happened, the property industry just experienced a short-term deflation, after that, it reflated and formed another more severe bubble from 2008 to 2012. Why was that happening? The key reason behind that was during the depression of the stock market in 2008, Chinese government realized the crisis coming, so it decided to save the whole economy by injecting 4 trillion Yuan into the economy, mainly invested in fundamental constructions. This action directly increased the supply of money in the whole banking system, which lead to another high inflation period. Except this significant monetary measure, Chinese government also low the loan rate and the reserve ratio of the commercial banks to protect the real property industry from failing. Consequently, over-investment in the real property industry helped China get through the ‘ice period’ but also recovered the housing price bubble.