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These fish don't need much shooting...

It’s become all too common for Western commentators to deride the Chinese government. They know that China hasn’t mastered the art of PR the way many businesses and countries have in the West, so it’s like shooting fish in a barrel for the media. What most of these people don’t realize is that “state capitalism” enables extraordinary action to correct market excesses.

The Chinese government knows that real estate prices represent a real issue for China today. If a property crash were to spiral out of control it would threaten the newfound wealth of many. In the same instance of property prices continue to rise without restraint almost no-one in China will ever be able to buy a home. That’s never been the intention of the communist party, there’s a sincere desire for everyone in China to be able to improve their lives. You might not get that from the rabid reporting back home, but it’s true all the same. Five minutes spent with anyone in the party and you can see that it’s not just rhetoric, they take the care of 1.3 billion people very seriously – perhaps more seriously than our own governments take responsibility for their people.

Because China’s real estate boom has been funded on far less borrowing than in other countries, and because China’s banks are state controlled, there is an opportunity to engineer a “soft landing”. And that’s exactly what is happening. Beijing has been working closely with provincial authorities to begin driving house prices down. Can you imagine your own government doing that? *Cue angry rant from unrestrained free market proponents*

The Beijing Government won't let you buy this house...

This is a good thing for everyone except perhaps property developers and the mega rich. Once property prices rise to more than 10 times the average wage for a reasonable sized home, property is significantly overvalued. Why? Because in order to buy a house most ordinary people will need some form of finance, and that’s normally a 20-25 year mortgage. (I thought you said people didn’t borrow money in China? I’ll come back to that in a minute.)

That mortgage requires interest payments (these may be at a historic low at the moment but that’s not likely to remain true forever), and once you take these into account (remembering that interest on mortgage payments is compound – so even a low rate can hit hard over time) it takes nearly 100% of one person’s wage (assuming they make the average wage) to make the payments over the lifetime of the loan. That means for a couple the other person’s wage is there to cover their other expenses, like clothes, food, drink, utilities, etc.

As property prices become higher than that 10 times wage figure, it starts to eat into the second wage and at around 15 times wages – it becomes economically impossible to afford to buy a home over a reasonable period of time, and over that 10 times wages bracket buying a home tends to significantly impact on people’s living standards. That’s especially true in developing nations when those wages don’t tend to have significant purchasing power.

So what happens when these thresholds are exceeded? In an equitable economy like Denmark’s it means that house prices are likely to stay static until such a time as wages catch up, and excesses are usually corrected quickly by the market economy.

In countries where significant amounts of wealth are concentrated in the hands of a very small number of people; like China or indeed the United States. It’s a different story. The mega rich can continue buying property as though nothing had changed, and they do. In the United States they become landlords and use your rent to pay their mortgage – when you rent, you’re making someone else rich at your expense (conversely if you buy a home on a mortgage you aren’t making yourself rich – you need somewhere to live, but you will eventually own your home and your retirement prospects are greatly increased by doing so, because you’ll stop paying for that home before you retire).

There's a big difference between a cash purchase and a loan installment.

In China there’s no point in renting out property because the returns for doing so are rubbish, and it takes an effort to prepare the property for rent – so the housing stock is “banked”. And unlike in the United States, the mega-rich don’t use mortgages to fund their purchases – partly because this avenue of financing isn’t strictly speaking available to them.

And in the second part of this article (also published today) we’ll have a look at what that means and why it’s necessary for the government to intervene in the property market.