But the location and quality of the buildings are most likely not controlled for in the official statistics. (Beyond ‘average prices’, no detailed description is available.) Suppose that the market has more buildings in the second-tier than the first-tier suburbs; then the average price may be lower than the location-controlled index. Thus, official statistics most likely underestimate the size of the housing bubble.
In real estate economics, the quality-adjusted property price index can be constructed by the sampling of repeated-sale (identical) properties (like the Case-Shiller index), by running a hedonic regression (in many academic studies for particular cities), or by using expert appraisal (like the frequently quoted Japanese land price index). Having a quality-adjusted property price index is a critical base for timely policy decisions.
What is happening in China now is familiar to any Japanese aged above 45. Japan experienced one of the largest property bubbles in the 1980s. The land price index tripled in five years. (The six-city price index for residential land rose from 39.2 in September 1985 to 105.8 in September 1990. The commercial land price rose from 27.9 to 104.5.) First, the land price rose in central Tokyo, then spread to first-tier suburbs, other large cities, second-tier suburbs and finally to rural land. The recent US housing bubble had a similar process of moving from prime to subprime mortgages. The quality of borrowers progressively worsened. In both Japan and the US, the loan-to-value ratio rose sharply towards the end of the bubble. Is this bubble now being repeated in China?
Many Chinese officials tell us that they believe the origin of Japan’s stagnation for the 20 years after its housing bubble burst lies in its failure to stand up to US pressure for the yen to appreciate. Indeed, the yen rose from a low of 260 yen/dollar in February 1985 to 200 yen/dollar 10 months later and on to the high of 80 yen/dollar in May 1995. Japan’s economic performance in the past 20 years has lagged its potential, but I would not blame yen appreciation for this. In fact, policy counter-measures – monetary easing and fiscal stimulus against too-rapid yen appreciation – grew stronger in 1986. Monetary easing continued until 1989. Considering what was going on in the property market, this monetary tightening and strong regulatory measures, such as restrictions on loan-to-value ratios, should have been applied much earlier, in 1987 or 1988. A bubble may not be completely avoided purely by monetary tightening, but the damage may be reduced by early tightening and prudential regulations.
The Chinese authorities are doing better than their Japanese counterparts in the 1980s. The central bank is tightening regulation of loan-to-value ratios and trying to end easy credit. But they are hesitating to take up the best policy – interest rate hikes and appreciation of the Chinese renminbi. The property bubble is a clear sign of overheating. China’s reported inflation rate does not show rampant inflation, but that was also the case in Japan in the 1980s. If the renminbi is appreciated, any overheating of China’s export sectors will be slowed, while standards of living will improve with higher purchasing power.
China did allow the renminbi to rise from July 2005 and it appreciated by 20 per cent by the summer of 2008. Yet, productivity increases by China’s export sectors have overcome this appreciation. It is high time China resumes appreciation. It should not be resisted because it is what the US wants. It is time for China to learn the right lessons from the Japanese experience.
This article was first published here in the Financial Times.
Takatoshi Ito is a professor of economics at the University of Tokyo.
It is more than likely that the housing bubbles in China are more serious than the official statistics shows and are likely to be a huge challenge to the Chinese authority in managing its economy as a whole.
China may be doing slightly better than Japan did back then, due to a number of reasons.
The first is that China is unlikely to completely bow to the US and EU pressure for currency appreciation, like Japan did in the Plaza accord. China may allow some appreciation when time is right, but that is likely to be tightly managed.
Secondly, repeated historical lessons of bubbles and bursting and their effects on the real economy may be learnt, that is, how to prevent bubbles from forming, growing and bursting too rapidly. I think China should be able to and can do better. When there are bubbles, the important task for the authority is not to burst but to manage the bubbles.
To use an analogue, when there is hyper inflation, the task is not to move the price back i.e. to deflate it rapidly, but to stop the further inflation. Managing bubbles is not completely the same as that, but has some similarity.
Thirdly, China’s capital market is not as free as Japan was or other major western economies, and its monetary authority has more instruments to use than its overseas counterparts.
Fourthly, the stage of Chinese economic development now is different from that of Japan in the late 1980s or early 1990s, and there is enough room for expansion including fiscal expansion to smooth out the similar problems that Japan faced back then, or the US is facing now.
So in my view, while the housing bubbles in China is potentially more problematic, China should have the capacity and instruments to manage them and manage them in a much better way.
64 million properties sit empty right now in China.
But prices keep going up.
How will it all end?