The Bubble that Will Not Burst: The Ins and Outs of the Chinese Real Estate Bubble
Imagine it is 2005 again. The United States is engulfed in its housing boom, spending $900 billion annually on real estate. Now take this figure and increase it by 500 billion dollars. China is currently spending $1.5 trillion every year on housing properties amid a destabilizing global pandemic (Xie 2020). For context, Stella Yifan Xie (2020) and Mike Bird of The Wall Street Journal note, “The total value of Chinese homes and developers’ inventory hit $52 trillion in 2019, according to Goldman Sachs Group Inc., twice the size of the U.S. residential market and outstripping even the entire U.S. bond market”. The housing bubble has turned into quite a dilemma for the Chinese government to deal with, especially in such an economic downturn due to the global pandemic.
China has been known for its very rapid economic and social growth. To maintain the economic growth China has experienced, various stimulus policies have been implemented. The ever-growing real estate bubble is a product of overstimulation of the Chinese economy. In response to the 2008 financial recession, the Chinese government implemented aggressive expansionary monetary policy to promote economic recovery. This stimulus policy manifested in very low interest rates and an increase in the monetary supply. Basic economic principles say that when interest rates are low and the circulation of currency is increased, investment will bloom. Investors are incentivized to borrow more money during periods of low interest rates since repayment to lenders is relatively small. This phenomenon, coupled with an influx of RMB, drastically increased economic growth (Nguyen 2019). Due to the abundance of capital in large urban centers like Beijing, Shenzhen, and Shanghai alike, fixed asset investment soared (Nguyen 2019). Fixed assets are usually longer term projects that hold value well relative to short assets, especially in periods of low interest rates. As you could guess, Chinese citizens threw their new found wealth into real estate. As speculation of price increases grew, so did the real estate bubble.
The higher the real estate bubble climbs, the greater the fall. Because asset bubbles are self perpetuating, market fundamentals no longer apply. Rather, the asset bubble is determined by those who participate. As prices increase, everyday people will take notice wanting to get in on the skyrocketing value. Usually, by this time, the economy as a whole is inflated by the influx of new money. Once this injection of new money spreads throughout the economy, not only does the original asset experience appreciation in price, but so do the surrounding goods and assets (Staff 2021). Original investors realize they have maximized their profits and leave the market. The remaining latecomers are stymied by lack of further new money. If monetary inflow into the Chinese real estate market were ever limited or stopped, buyers would no longer be able to afford these homes resulting in minimal gains by late investors. By the same process of how the bubble came to be through speculative optimism, the real estate bubble will crash through speculative pessimism about the decreasing profit and activity within the real estate market. This leaves the everyday people who bought in too late with little to show except substantial economic ruin. The original wealthy investors who sold out of the market earlier are left with little to no scarring while the brunt of economic downturn is felt by the average citizen.
Chinese citizens have placed 78% of their wealth within residential property. The market is proliferated through mob mentality. As more and more people buy into the real estate market, they feel the need to secure a house because they believe as more houses are bought, prices will continue to rise and supply will fall. Instead of trying to either wait out the bubble or for policies to be implemented to limit the bubble, people grow weary, scared that they will miss their chance to buy or invest in properties. The Chinese government has to be careful when implementing policies to stop the bubble from increasing due to the already large amount of wealth within the property market. Limiting the housing market would result in very substantial losses in the wealth of Chinese citizens and severe economic costs for the whole economy. If such measures to limit the bubble were taken, the policies would have to be slowly applied and thoroughly discussed. The resulting effects of such policies reach beyond the financial world. Both economic growth and social stability are risked if any immediate actions are taken.
The Chinese people know this. Chinese citizens have created their own artificial wealth preservation entity because the Chinese government would have to take great care when reducing economic growth and wealth of a market responsible for the majority of their positive economic growth.
Not all US cities are the same in size or wealth. China is no exception. The real estate bubble has deepened a growing wealth disparity between those in mega cities and smaller towns. This divergence of wealth is amplified by the size and scope of the market in China. From cities to towns alike, a large number of houses and apartments were built in the early 2010s to meet the demand for property after the implementation of stimulus policies. Urban centers still attract buyers more than small towns, resulting in a large number of vacant properties that place a substantial financial responsibility on smaller developers and small towns. As prices soared in Beijing, prices plummeted in Hegang and towns just like it. “Hegang, a town near the border with Russia, briefly found itself in the spotlight after homes there were advertised for just 20,000 RMB, less than the cost of a square metre in Shanghai” (Economist 2021). A very different experience is seen in Shanghai, where you are asked within minutes, to pledge your life savings to a property, “When his number was chosen, John Chen, an engineer in Shanghai, had two minutes to decide whether to drop 9.6m RMB ($1.5m) on a house. “It emptied my bank account. But I did not hesitate,” he says. (Economist 2021).
Poor workers are not able to take advantage of such opportunities. Barriers like income and the Hukou housing system proved very difficult to overcome for the majority of the Chinese lower classes. Take the city of Zhengzhou, for instance. More properties were built from 2016 to 2019 than in the entire decade prior. There has been an immense struggle to sell these properties as potential buyers are simply not able to afford the prices. A standard one bedroom apartment costs 4,500 RMB monthly. The average worker at Foxconn, a large supplier of jobs in the Zhengzhou region, earns less than 4,500 RMB a month (Yu 2021). These laborers are disadvantaged to the point where it is unrealistic to expect the local population to purchase these properties. Buyers who have the means to purchase these properties would rather shell out extra in the hopes of obtaining the elusive apartment or house in Beijing, Shanghai or any other mega city. At the same time, Hukou housing permits restrict movement of citizens into highly sought after residential areas. These permits are very hard to obtain, especially for middle to low class citizens to migrate into urban areas. Thus, the Hukou system has barred outsiders from entering already overcrowded areas in an attempt to drive the purchase rate of properties in less sought after areas up. In actuality, the Hukou system has ensured the separation of class within Chinese society is maintained.
Whether you want to consider them skeptics or hopeless optimists, some people have expressed that the housing bubble should not be of great concern. For one, the government is starting to change the use of the Hukou housing system by providing easily obtainable permits in towns on the outskirts of mega cities. In parallel, the government has invested in establishing hospitals and prestigious education systems in these suburban towns to draw out otherwise speculative owners to buy more reasonable properties in less crowded areas. There has even been an initiative to help homeowners destroy their old, outdated and rundown homes for cash in order to clear some of the vacant new properties built (Economist 2021). As the government has taken some strides to reduce the bubble, each step requires utmost precision. One misstep and the bubble might finally burst. In essence, urban Chinese have bet everything on their homes. They now have nearly 78% of their wealth tied up in residential property, versus 35% in the U.S., where more people invest in stocks and pensions.
Sources
Belsie, Laurent. 2015. “Demystifying the Chinese Housing Boom.” National Bureau of Economic Research, July 2015. http://www.nber.org/ digest/jul15/demystifying-chinese-housing-boom.
The Economist. 2021. “Can China’s Long Property Boom Hold?” The Economist, January 30, 2021. https://www.economist.com/finance-and-economics/2021/01/25/can-chinas-long-property-boom-hold.
Nguyen, Trieu. 2019. “China’s Growing Real Estate Bubble.” Mises Institute, October 24, 2019. https://mises.org/wire/chinas-growing-real-estate-bubble.
Staff, Investopedia. 2021. “How Do Asset Bubbles Cause Recessions?” Investopedia, March 4, 2021. https://www.investopedia.com/articles/ investing/082515/how-do-asset-bubbles-cause-recessions.asp.
Xie, Stella Yifan, and Mike Bird. 2020. “The $52 Trillion Bubble: China Grapples With Epic Property Boom.” The Wall Street Journal, July 17, 2020. http://www.wsj.com/articles/china-property-real-estate-boom-covid-pandemic-bubble-11594908517.
Yu, Sun. 2021. “China’s Housing Crash Exposes a Growing Regional Economic Divide.” Financial Times, March 29, 2021. https://www. ft.com/content/bbc5c5c0-f7d1-4032-968a-bac10c07707e.