China can afford to let its bubble economy burst
Andy Xie says China should wean itself off the bubble economy that's now doing more harm than good, by tightening its money supply and restraining its rampaging state sector
Right before unveiling the new cabinet line-up, the Chinese government announced it would strictly enforce a 20 per cent capital gains tax on property sales. It was presented as a response to the resurging speculation in the market. Does it signal that the new government won't tolerate the property bubble? It is too early to say.
Speculation and corruption have come to dominate China's economy since 2007. The two form a temporary equilibrium to sustain growth, though at increasingly low efficiency, as reflected in the rising inflationary tendency of the economy.
China has depended on rapid monetary growth, through bank lending, to fund fixed-asset investment. A significant chunk of the monetary growth becomes corrupt income. The renminbi's appreciation outside China, and depreciation at home due to inflation, have pushed the surplus liquidity into the property market, which then becomes government revenue again.
Through recycling the corrupt income into the government's coffers, property speculation has been critical to the stability, albeit temporary, of China's current growth model. Hence, cutting off property speculation without stopping corruption would lead to currency devaluation and an economic hard landing.
The latest surge in speculation came after government action late last year. Starting in late 2011, the property market has collapsed in overdeveloped cities such as Ordos , Wenzhou and Sanya . With negative sentiment spreading, the resulting fall in local government revenue led to action to rescue the market. Banks eased restrictions for second or third mortgages. State-owned enterprises borrowed to bid up land prices, pumping up price expectations. Inflation accelerated, scaring anyone with cash in hand. And, lastly, the renminbi began to hit new highs. These four forces have propelled property speculation again.
The same thing happened in 2008, though on a much larger scale. The global financial crisis spooked China's speculators and the market pretty much collapsed across the board. The ensuing stimulus policy used credit to reinflate the property bubble. This was done by expanding the M2 money supply, which doubled in four years. History will judge that the 2008 stimulus policy sent China's economy down the path to crisis.