Credit and Taxation: The Key to Tackling Asset Bubbles

Credit and Taxation: The Key to Tackling Asset Bubbles

People look at models of a housing project in Foshan, south China’s Guangdong Province, on May 17

Tackling asset bubbles was mentioned as a measure to reduce costs—one of the five tasks of the supply-side structural reform—at a July 26 meeting held by the Political Bureau of the CPC Central Committee. The meeting studied the current economic environment and hashed out plans for economic tasks to be carried out during the second half of 2016.

But what exactly are these asset bubbles? Since the meeting did not give any specific details, many market players have interpreted the term in different ways. Most people believe that, judging from the market’s current conditions, the asset bubbles that the government has targeted could mean all kinds of assets, including those in the stock, bond and property markets.

However, what the meeting has drawn attention to is the real estate bubbles. This is because the yuan’s exchange rate has stabilized since the Brexit vote and the bubbles in China’s stock market have burst following the stock price plunge in June 2015. Therefore, in order to curb asset bubbles, the government should focus on the property market.

China has released an array of loose monetary policies since 2014, evidently in an attempt to boost economic growth. These measures included cutting interest rates and reserve requirement ratios for commercial banks several times, thereby pumping a large amount of liquidity into the market. Unfortunately, the credit expansion failed to channel funds into the real economy—instead, the liquidity simply ended up trapped inside the financial system.

After the stock market plummeted last year, some of the liquidity quickly poured into the real estate sector, causing home prices in first-tier and some second-tier cities to balloon drastically.

Although some analysts have argued that the property market has become bloated due to a lack of alternative investment avenues, the fact is more likely a result of investors using monetary leverage from banks to speculate in the housing market.

Moreover, the large amount of liquidity stagnating in financial markets but not flowing into in the real economy has resulted in a sharp decline of private investment growth. If the asset bubbles, property bubbles in particular, are not tackled, China’s real estate and financial markets will be exposed to huge risks, and its macroeconomic growth will face increasing downward pressure.

The key to dealing with this issue lies in restoring the function of homes as dwellings rather than speculative assets or investments. The government should use taxes to strictly separate home investors from ordinary buyers who are actually looking for someplace to live. Furthermore, the government should use stricter taxation rules, rather than home purchasing limits, to curb speculative activities in the market. Reality has already proven that such purchasing caps have a very limited effect.

Additionally, fast-growing bubbles in the property market are also a result of credit expansion policies introduced by the government. When speculators flood into the market with high leverage and low interest rates, housing prices are bound to surge.

In addition to using taxation rules to separate speculators from ordinary buyers, credit policies should be tightened to curb speculation by increasing down payment requirements and mortgage loan rates, and enacting stricter scrutiny of purchasers’ income and ability to repay mortgage loans.

Therefore, the key to tackling current asset bubbles is to curb real estate bubbles through credit and taxation, rather than with administrative measures such as purchasing limits.

This is an edited excerpt from an article written by

Yi Xianrong, professor at School of Economics, Qingdao University, originally published in Economic Information Daily

Copyedited by Bryan Michael Galvan

Comments to yushujun@bjreview.com