March 16 2010
The Chinese official statistics say that the average rise in property prices was 10.7 per cent in February. The increase is accelerating from a year-on-year rise of 9.5 per cent in January. However, the data may significantly underestimate what is going on for prime properties in China. My friends in Shanghai and Beijing say the rate of price increases of typical housing units is above 50 per cent a year and may reach 100 per cent, and that new property developments are spreading fast from first to second-tier suburbs, with less convenient transportation.
According to the official statistics, the rate of price increases of newly-built residential buildings (at 90 square metres and below) in Beijing, Shanghai and Shenzhen are 19.3 per cent, 11.6 per cent and 19.6 per cent, respectively. In the same category, the highest property inflation was in Sanya, Hainan Island, at 57.9 per cent. However, 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. 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 Y260/$ in February 1985 to Y200/$ 10 months later and on to the high of Y80/$ 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. The 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.
The writer is a professor of economics at the University of Tokyo