Time to pull the trigger
Beijing needs to apply Bazookanomics and take aim at the mainland property market, after failing to cool it with ineffective attempts at reform
Beijing's carrot and stick approach to managing the economy has generally delivered more of the latter over the years.
This was the essence of Chinese Bazookanomics which, until the 1990s, worked quite well on Party members, state-owned enterprises (SOEs) and virtually everybody else operating in a tightly planned economy where a combination of self-discipline, quantitative restrictions on every aspect of economic life and sacrifice for the common good were the watchwords of the system.
But with economic liberalisation, Bazookanomics has lost much of its firepower, as private-sector economic agents assert their self-interests.
This is particularly clear in the real estate sector.
Since 2007 the mainland government has regularly pledged to bring down property prices and tame construction activity with a series of policy restrictions and penalties designed to force rule-breakers back into line with official objectives.
Some restrictions are harsh, such as stopping residents of one city buying homes in another, the banning of the purchase of second homes, restricting credit for property developers, and even imposing outright caps on property prices.
However, the property bubble keeps getting bigger.
In August, the prices of new homes surged 7.5 per cent from a year earlier and the price of land is rising fast, even though a large proportion of new homes remain unoccupied and new housing starts are breaking records.
It is now clear that politicians’ tough words are not enough to scare off real estate buyers
The government knows the reasons behind the bubble: negative real interest rates and the low cost of holding on to real estate.
In 2010, it announced a pilot scheme to introduce a property tax in Chongqing and Shanghai, and vowed to liberalise interest rates. Three years on, however, very little, if any, progress has been made on either front, apart from more vows and more frank words from senior officials.
It is now clear that politicians' tough words alone are not enough to scare off real estate buyers - not least because SOEs, state-backed banks and even local governments are breaking the rules with seeming impunity.
Moreover they have developed sophisticated ways to do so without appearing to be renegades. They form joint ventures with private sector players to circumvent rules, use financial institutions and complex financial products and blame the invisible hand of the market when things start to go wrong.
The loss of credibility for Bazookanomics over the last decade means the current handling of the real estate market has become a joke.
If the government is serious about limiting the risks of shadow banking, it should lift the ceilings on deposits. But we should not hold our breath, as Chinese officials are mostly masters of kicking the can down the road.
A quarter of a century ago, the central bank made it a goal to liberalise interest rates in five to seven years. But today, it is still only tinkering around the edges.
All the hurdles are self-imposed, and even imaginary.
First, there is the notion that China must keep interest rates low to support the economy. Secondly, there are fears that higher rates would encourage and reward hot money inflow, making the yuan too strong for exporters.
Overcoming the fear factor requires tough decisions, but officials are reluctant to take them.
For example, despite terrible pollution, China's water wastage is widespread, as tariffs are still far too low. Relative to incomes growth or inflation, water tariffs have declined in the past 10 years.
Another case in point, to reduce oil consumption, the government tabled a fuel tax bill 10 years ago, but a civilised debate killed it. Today, no one even talks about the fuel tax. The electricity price is far too low, but who dares raise it to its true economic value?
In the past three decades, high economic growth has hinged on robbing households to subsidise business - to be precise, those businesses that are fortunate enough to access bank credit.
Today, the state sector and well-connected private businesses have become addicted to cheap credit. They stifle emerging competition from small and medium-sized enterprises.
Cheap credit has also worsened misallocation of resources, and led to a credit explosion. In the past 12 years alone, for example, total credit in the banking sector surged 534 per cent.
Negative real interest rates have undermined households' ability to consume, leading to an imbalanced economy that relies heavily on investments. In 2012, household consumption made up less than a third of GDP.
An undervalued yuan has the same effect of hurting household consumption: similar to high import tariffs, it is equivalent to cutting the real household incomes, making imports more expensive.
Negative real interest rates directly cause asset price inflation that, in turn, sucks more resources into the sector.
What to do? The government must use the bazooka it has and fire it at the property sector, as letting the market know it has a bazooka is not enough. The sooner it fires, the better.
