China’s Property Bubble Spreads, Producer Prices Rise

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May 12 – Inflation is a growing concern in China as property prices and the country’s producer price index climb record pace, causing policy concerns to raise interest rates and allow the yuan to appreciate.

Property prices rose at a record pace in April with a 12.8 percent jump in 70 cities; consumer prices climbed at the fastest rate in 18 months and the producer price index, the measure of selling prices for domestic producers, increased by 6.8 percent in April.

“Higher inflation, rising property prices and wages all point to the risk of overheating,” Kevin Lai, an economist with Daiwa Capital Markets in Hong Kong told Bloomberg News. “Policy makers are hesitant because of Europe’s debt crisis, but higher interest rates is the only way to contain rising bubble risks.”

So far, the government has avoided using the central bank interest rates proposal, and instead they took measures to curb property speculation and drained cash from the financial system via three increases this year to the deposits banks as reserves.

Japan faced a similar dilemma of accelerating inflation and surging house prices in the late 1980s. The concern now is whether China will make the same mistakes. Japan suffered when their asset bubble burst, the stock market fell by more than 80 percent, land prices fell by 60 percent and it took almost a decade to resolve the banking crisis.

Some analysts argue that China is a much larger country in terms of territory and population, and has higher long term GDP growth potential. And because the Chinese government has controls over capital investment, it is unlikely to suffer a Japanese-style economic meltdown.

However, a valuable lesson learned from Japan is that it is important to understand the risk of a sharp correction in the asset market; also economy imbalances have to be corrected by macroeconomic measures accompanied by microeconomic reforms. The government believes that the microeconomic reforms that have been implemented in China for some time give the country a chance to avoid a major economic downturn.