The Bubble

Cameron Griffith

Economic bubbles have historically come as a complete surprise without any telltale signs of an impending crash. Today, the signs of the largest housing bubble in history stand hundreds of stories tall in China, with no one seeming to care.

In the past decade, dozens of “ghost cities” have sprung up across China. These cities cost billions of dollars to build and are capable of housing millions of people. The most famous of these ghost cities, Ordos, boasts rows and rows of newly completed skyscrapers, lush parks, art museums, and concert halls, most of which stand completely unoccupied.

The rapid growth of the Chinese middle class is largely responsible for this enormous bubble. For many Chinese, real estate is the only asset class in which they believe they can make sound investments, as domestic stock markets are considered too volatile for risk averse investors. Furthermore, bond yields are kept artificially low to encourage development, and the Chinese government limits the amount that citizens are allowed to invest in international assets. As a result, the rising Chinese middle class has been forced to find an alternative investment for its newfound wealth.

In the past year the Shanghai stock exchange plummeted from its all-time high, losing nearly 40% of its value in the span of four months, while, during the same period, housing prices in Shanghai rose 31.2% according to the National Bureau of Statistics. The combination of all these factors has led Chinese middle class investors to the conclusion that real estate is the safest investment opportunity available to them.

Investment in real estate has led to a significant increase in the demand for new housing projects as many middle class families buy one or two extra apartments to meet their investment needs. This brings us to the other half of the problem: strict government quotas for provincial GDP growth. Every year the national government stipulates a certain level of GDP growth which provincial leaders must meet or else face harsh penalties. The easiest way for leaders to meet these standards is to invest heavily in the construction of entire cities filled with massive apartment complexes. And because of ballooning demand, these apartments are often bought instantly, even though the new owners have no intention of living in them.

The entire system creates an upward spiral of growth, with new apartment buildings being built faster than Chinese urbanization can fill them. The severity of the problem is outlined by the China Center for Urban Development, which found that the land used for urban construction rose by 83.41 percent from 2000 to 2010, while the Chinese urban population saw an increase of just 45.12 percent in that same period. The result of this disparity is vast, uninhabited, concrete jungles that leave provincial governments with inflated GDPs, and the central government none the wiser.

Were it not for the Chinese government’s comprehensive use of a variety of financial tools and public policies to ensure consistent economic growth, it is likely that this runaway construction would have already resulted in one of the largest financial bubbles in history.

In order to maintain steady growth in the housing market China’s central government employs several contractionary and expansionary policy measures which have so far been largely effective. When housing prices rise too rapidly, the government tightens credit requirements, raises down payments, and imposes restrictions on the location and quantity of apartments that citizens can buy. When the government detects a cooldown in the housing sector it does just the opposite by loosening credit restrictions and lowering the required down payment.

These drastic policy measures have made it much more difficult for those wishing to purchase a home or invest in real estate for the long term.

Richard Li, the head of investing at Zhong Tai Construction Group in Guangdong, said that “Moving in the same direction as government policies leads to investments which yield much less risk.”

Li added that it is more beneficial, from an investment standpoint, to anticipate governmental policy changes than it is to try and understand typical market indicators.

The world is waiting to see what the end result of these policy measures will be, but if we examine the devastating effects that the US housing crash had on both the domestic and international economy a clearer picture of the potential of this economic time-bomb emerges.

Both bubbles share the same root cause, in that home buyers expect already-rising real estate prices to continue to rise. In the United States, housing prices had risen continuously since the mid 1990s, while housing prices in Shanghai and other major Chinese cities have seen upwards of 30% increases in recent years. These staggering figures indicate how, in both cases, green-eyed investors can become blind to the realities of the market based on the fallacy that what has happened will continue to happen.

Shortly after the US financial crisis in 2008, it became clear that the economic implications of the housing market crash would resonate for years to come. The Case-Shiller housing index shows that house prices plummeted from their record highs to a ten-year low, leaving millions of people underwater and forcing them to foreclose on their homes. Millions lost their savings in the coinciding market crash, and have been forced to postpone their retirement.

In China, this phenomenon will only be intensified. As few jobs in China offer any form of retirement planning, and the Chinese financial sector lacks few investing alternatives, many people rely solely on real estate investment to meet their long term financial needs. A report undertaken by the China division of Citibank estimates that 65% of personal wealth in China is tied up in real estate, compared to 35% in the United States. This means that when the housing market collapses, millions of Chinese families will lose their retirement savings, college funds, and possibly even their homes.

This grim outlook has not scared off Chinese investors, many of whom have faith that the government will be able to mitigate the threat of a housing market collapse, as they have proven adept at ensuring consistent economic performance.


According to Li, “the purpose of government regulation and control has been achieved” and that “China's real estate sector will not end up in the same bubble as Japan, nor will it suffer the same crisis that the United States did.”

The optimism of the rising Chinese middle class, coupled with the meticulous control of the Chinese government, have created the perfect conditions for the largest real estate boom in history. Although this deft control of the housing market has been successful at staving off disaster thus far, the government is only adding fuel to the fire by allowing the housing bubble to grow far larger than it would under free market conditions and ensuring that the fallout from the eventual crash will most likely be even more devastating.