What are the Similarities and Differences Between These Two Bubbles?

    After going through the two housing price bubbles, I wonder if there are some similarities and differences between these two. In this post, Iprimarily talk about some similar and different results of the two bubbles, which were due to different policies, and try to dig out the stories behind these results.

    In the two bubbles, I found that the causes of  the two bubbles were similar, but the stories behind them were quite different. Why was that?

Similar causes:

• High Inflation

    In the medium period of the two bubbles, high inflation rate emerged in both cases. However, the reasons were different. In Japan, high inflation was due to the extreme low discount rate, which dramatically brought the money supply up, whereas, in China, the first period's inflation (2005-2007) was because of the explosion of the economy, and the second period's inflation (2008-2012) was mainly caused by the 4 trillion RMB government injections, which also substantially increased the currency in circulation. After the appearance of high inflation, the reactions of the citizens in both countries were surprisingly similar. They both had an expectation of continuous inflation next period, and invested more in the real property industry, which indulged the housing price bubble.

• Land Price

    When the bubbles in both countries formed formally, the land prices in either country were unbearably high. However, the reasons were pretty different. Chinese government has monopoly control on the land trading. Local government misused the power of pricing the land to enhance income, because they were assigned missions to hit some GDP targets. Consequently, the land of price reached at a very high level, which still remained high recently, while in Japan, the land trading is controlled by the ‘invisible hand’- the land market. The high land price during the bubble was totally results of severe speculations. The different reasons for pricing land may be a crucial factor that bubble in Japan burst whilst bubble in China still exists.

Differences of two bubbles

    Although many similarities appeared among these two bubbles, there were a few differences of them.

·        Aggressive bank behaviors in Japan but conserved banks acts in China

   

    At the end of the bubble in Japan, commercial banks faced the high costs due to the high discount rates, have to loan to risky firms in order to obtain high returns to survive, while in China, most of the commercial banks are state-owned or at least have state as an influential shareholder, so they do not concern too much about the returns but consider the risk as the first place. Therefore, commercial banks in China behaved relatively conserved to Japanese banks. In other words, Japanese banks took too much risk, whereas Chinese banks had little risk because they had strict investigations before making a loan and involved state as a strong back-up.

·        Different results so far

    When the bubble occurred, both governments took measures to restricted money supply and cut loans to real estate companies. In specific, when the bubble appeared, Japanese government attempted to control the money supply, so it up-regulated the discount rate to commercial banks. Additionally, some commercial banks cut loans to real estate companies However, these actions lead directly to the miserable tragedy. In China, Bank of China enhanced the reserve ratio of commercial banks several times to reduce the money supply, and recently, commercial banks stopped loaning to some real estate companies. But the bubble still remains.

An explanation for the different results: Speculation dominated the bubble in Japan but both real demand and speculation donminated the bubble in China

    One of the most important reasons that caused the Japanese bubble was the overheated speculation. During the bubble time, almost everyone engaged in the property industry to seek speculative opportunities which enhanced the housing price dramatically. In China, speculation was also serious when the bubble occurred. However, there is another dominant factor behind the bubble: high real demand of house. Cultural attitudes determine that having a house means having a home. Therefore, when young people marry, they need to purchase a house. Another factor that drives the high demand is due to the urbanization process. As urbanization process is accelerating in China in recent years, megacities require a lot of labors. Therefore, more and more people swarmed into these cities. Their needs of houses drive the demand even further. This may be another reason why the housing bubble still exists in China. In the next post I will explain the reasons of existing property bubble in detail.