Critical Thinking

What the value of money to drop down,

What are the causes China’s bubble, and what effect would it have?

China is one of the fastest growing country in the world. It has the second biggest economy, and is one of the biggest contributor to the global economic growth. In fact, its gross domestic product is only second to that of United States. China’s gross domestic product value is high as 11.2 trillion US dollar in the year 2016, which is 7.37 trillion US dollars away from the United states, which has a total of 18.57 trillion US dollar for the gross domestic product. With this fast growth rate, however, government is trying to keep the money inside of the country by imposing a capital control. Capital control is a limit of the flow of foreign capital in and out of the domestic economy. Chinese people doesn’t have a lot of options of what and where they can invest; thus, most people chose to invest in stocks and real estate. As there are excessive competitions and demand among investors while the number of stocks and land states stayed the same, the demand curve would shift to the right, making the price of investing rises rapidly. This marks the beginning of the formation of China’s bubble. 
Acknowledging and understanding foreign country is very important in this globalization world. Because China is one of the biggest and most productive country, their influential power are also tremendous. If China’s economy went into recession, then other countries would most likely be influenced by it, pulling down other countries all around the world as well. Recession is a span of time where businesses aren’t able to expand, there is a drop in the gross domestic product of the country of more than two successive quarters, unemployment rate rises, and housing prices goes down. This led to the research question: “Will China’s bubble burst, and what effect would it have?”
The biggest contributing factors that lead to recession is inflation. Inflation is the persistent drop in economy’s price level. This causes the value of money to drop down, price of goods and services will be raised, requiring more money to acquire the same task as before. The effect of inflation is a reduction in consumer’s spending. People will have more incentive to save their money, leading to a decrease in the economic activity and the country’s gross domestic product. The gross domestic product could be calculated by adding the consumer spending (C), Investment (I), Government spending (G), and the difference of exports (E) and Imports (I) together. As mentioned, because people will have the incentive to save, consumer’s spending, one of the factor in the equation, will drag down the country’s gross domestic product value. 
With China’s current state, it is very likely that China’s bubble will be popping, and that the whole world would be negatively affected by it. In 2015, China’s average price-earning ratio in the stock market rose dramatically, beating the average price-earning ratio of the other countries in the world. Price earning ratio could be calculated by dividing the market value per share by the earning per share. The inflated price in the investment market is a sign of inflation as more money is required to buy the same amount of stocks and real estates compared to before.
Another reason for an increase in the price of house and property is the middle-class trap. Because China is developing dramatically, more and more people are entering the middle class social level and are looking to invest their money in a hope that they will receive even more money. The two options that China have available for them to invest in , however, was so limited to only stocks and real estates. Subsequently, there were aggregate demand in investing money on these two factors, having a large possibility to lead into demand-pull inflation.
The demand-pull inflation shows the aggregate demand of Chinese people wanting to invest on real estates increases continuously. From AD1 to AD2, there is a big shift in demand to the right, however, the price increased only a 
             Demand – pull inflation 
little bit from P1 to P2. This is the starting phrase of people investing, In this phrase investors are able to invest in the two options without needing to compete with others as the supply of real estates and stock are more than enough for everyone to choose to invest on. The next phrase, which is a shift from AD1 to AD2, more people are entering the middle class where they receive money and wants to spend it. With a fixed amount of the long run aggregate supply, it could be seen that despite a little shift of y2 to y3 to the right, the price increased rapidly, from p2 to p3. This is because aggregate demand curve is forced to travel upward along the long run aggregate supply, indicating how the number of people willing and able to invest are close to the available number of real estates and stocks within the economy. The last phrase as shown in the diagram with a shift of aggregate demand as even more people are entering the middle class and are looking forward to invest money from AD3 to AD4 resulted in an inflation. This is because while there is an increase in the price level of economy, there weren’t any additional supply, meaning more money is required to purchase the same amount of supply at y4.
Chinese people are over investing in stocks and real estates. For example, there have been an overproduction of buildings, leading to a so-called ghost cities. There is an opportunity cost, which is the best alternative choice foregone in the usage and raw materials used in constructing houses and buildings. With high price of investment, the prices of buying or renting these building would also skyrocketed. By the end of 2016, China’s overall house price increased by eleven percent. Shanghai had 31.2 percent increased while Xiamen had forty three point eight percent increased. This could result in even more people wanting to gain wealth by buying houses. The offer of mortgage lending as a percentage of total loan. The percentage have increased from thirteen percent in the beginning of the year 2015, to about fifteen point five percent in the present. Chinese people really wanted the mortgage from the property to the extent where married couple were even willing to divorce. This is very dangerous as the demand for the houses would exceeds the supply of the economy, the result might left people of the lower class unable to afford housing. 
China grew about seven point four percent last year, which is zero point one percent away from what their main goal was. This is the slowest expansion seen from China since the year 1990. Alongside the bad news from slow growth in the country and the decrease in the commodity industries sector, there is still a growth present in other areas such as developing service, digital and various consumer sectors. Following and tracking where the money within the country go is one of the way to find the cause of these conflicts. Specifically, the money route in March, where China’s credit growth tripled will be tracked. As a result from tracking where the money came from, it have been found that the manufacturing purchasing manager’s index dropped from fifty point two to fifty point one. This is an evident that the money was not used and invest into industries. Instead of spending money or investing money in industries, most of the money seems to be going to the households. Chinese people have been borrowing money from banks to buy houses. In March, there was approximately six hundred thirty nine billion yuan or ninety nine point six billion US dollar money borrowed to buy household out of the total 1.37 trillion yuan the Chinese citizens have borrowed. The loan for property also skyrocketed with an increase in over one hundred forty one percent each month. The number even hit four hundred forty billion yuan. Increase in investment and price of the property and household led to more property transaction. Shenzhen was the leading city with price of property increasing by more than sixty three percent. 
With the trend in borrowing money to invest in buying property and houses, the property developers grew more and more with corporates offering bond insurance. This attracted a lot of the Chinese citizens. Consequently, the bond insurance increased from eighty seven billion yuan in the span of only one month from February to March, the bond insurance reached six hundred ninety five billion yuan. Investors in China are looking out to replenish their land banks. thirty investors were competing the the bid foe a land parcel, which ended up selling at the price of five point four billion yuan. Even though the country is developing rapidly, there is also a huge jump in the number of loans and debts. Thus, the quick pace of China does not guarantee that Chinese citizens will be able to repay their loans back in time.
The real estate market was uplifted even more by the policy given out from People’s Bank of China, also known as PBcC. In February, the People’s Bank of China had looked into supporting the housing market. People’s Bank of China supported the housing market by reducing the down payment for people who purchase their first home from twenty five percent to only about twenty percent. Furthermore, there is also a decrease in the down payment in purchasing the second home, reducing from forty percent to thirty percent. In some cities that are listed as tier one, or the top city with prosperity and money, People’s Bank of China didn’t offer the reduction. An example of this city is Shanghai and Beijing. When analyst and policymakers observe China, cities are classify into Sinostep. In other word, cities are broken into tiers which ranges from one to four. The city’s population, development of services, infrastructure, cosmopolitan nature was a mean measure of which tier the cities would be in. Tier one is of the largest and most prosperous cities while tier 4 is of the smallest and poorest city. This was the first policy made by the government to stimulate house purchases in the tier two, three and four cities, or the cities that are not very prosperous, in an attempt to get rid of the enormous stocks of empty houses in these cities. An example of the cities in tier lower than one includes Shi Jia zhuang, shen yang, Guiyang, and many more. 
People’s Bank of China monetary policy have also led to the expansion of the housing market. The criticism being given to the People’s Bank of China is that their monetary policy was too loosen.
It is striking that money supply including the cash in circulation and corporate and government demand deposits grew much faster than household deposits and other deposits, cash in circulation and corporate and government demand deposits added together. This shows that loose policy is only increasing one area of the economy which is to increase the investment in property and house. Because other areas within the country does not seems attracting or have a lot of incentive for investors to invest, it reflects why so much money was put into investing on house and property. 
There was an increase in the house and property price not only because other areas lack the attractiveness to attract investors, but also because of the limited investment opportunities. There were only three options in which Chinese citizens could invest money to generate revenue. The three options include savings deposits, the stock market and the property market. The equity market did not attract investors ever since the collapse of its market in September, 2015. The country’s interest rates have been declining, thus investors are regarding the investment in property as the most profitable option. Investment in property and house are closely linked, therefore when 
there is an increase in the demand of property, the demand of house will also go up.
Another factor that was added to the rise in price an demand of house and property is the increase in the migration from lower tiers cities to high tiers in an attempt to gain wealth though buying houses after staying for 3 years.
With the limited option of investment, money spent on investment would decrease. Eventually, the country’s value of gross domestic product will be dragged down.  

We Will Write a Custom Essay Specifically
For You For Only $13.90/page!


order now

The graph on the left shows Shanghai’s stock exchange composite index. Composite index is the combination of equities, indexes or other factors in a standardized way. The graph shows that ever since June 2015, there is an overall decreasing trend. The decreasing trend of the stock market portrays how the capital within the city is in an outflow direction.   

 

The graph on the left is a supporting evidence of the claim about the outflow of the capital as stated previously, which that shows China’s capital flow. There was an overall of negative capital flow with only 2 months (January 2015 and February 2017) being an exception. 

Most economists believe that China’s bubble will pop. Ma Jun, the chief economist of the People’s bank of China’s research bureau, have been pinpointing how China bubble is very dangerous and if burst would pull back other countries especially countries in Asia as the countries are closely interconnected. The pop of China’s bubble might leads to recession, dragging other countries all around the world down with them. Because China is currently considered to be the biggest commodity importer, the pop of China’s bubble will also have a large negative impact on the major commodity-producing emerging market economies. These countries include Brazil, Russia and South Africa. Moreover, the pop of China’s bubble and inflation will be a huge incentive for consumer to save their money instead of spending, as a result the domestic and international businesses within the country will suffer severely. Furthermore, this will affect China’s relationship toward other countries. For an example, if China bubble pops, then it will complicates the goal of reducing the U.S.-China bilateral trade deficit. This is because slowing Chinese economy would most likely weaken the Chinese demand for U.S. imports. The recession would mean that China’s currency might drop; therefore China would have more incentive in exports than to imports, which would not benefit them when they have weak currency.   
While most economists have the view point that China’s bubble pop will  result in the worst economic and financial crisis, some economists disagree. There have been many view points regarding how the effect of China bubble popping wouldn’t lead to a huge financial crisis. The first evident is from its past where China’s market have never collapse before. Another evident is clearly shown through the comparison between China’s current state and the state in encountered by the former incident of America in the past, where the causes of crisis was due to bank lending money to borrowers who doesn’t have the potential to pay them back, not getting any repayment at all. On the other hand, in China, real estate borrowers have a collateral which guarantee a repay that the bank will gain. 
To solve this problem, government could adopt the Home Purchasing Restriction, making the purchase of home more restrictive and less financially attractive until the house market got down below what they are aiming for. There would be a rule set out about how many houses a person can own and buy. Furthermore, to reduce the incentive for people to buy houses, government would increase the down payment, which is the initial payment a person has to make before buying something, for each additional house a person buy. This could range from twenty to thirty five percent for the first house to sixty to eighty percent for the second house. In China, there are no yearly property taxes, so what the government does is imposing a taxing policy on house sellers After that, government will take the house purchasing restriction out so that people could buy home and real estate, thus gaining regaining momentum. 
Seeing clearly that the main problems arose were the result of limited investment options within the country, Chinese government is also slowly cracking down, and is thinking of expanding investment options aboard. Recently, the Chinese government is trying to cautiously lower capital controls in a hope that if Chinese households are able to move more of their funds abroad, it would lead to a lower demand for domestic property investment which would bring the housing and property price down.
In conclusion, it could be understood that limited investment opportunities, high demand in investments, decrease in gross domestic product, inflation and many more factors have contributed to the increase in the price of house and property, further expanding the China’s bubble and putting not only China’s citizens but the whole world in fear of it popping. If China’s bubble pop, which will then leads to recession. Recession could effect the economy in a bad way as businesses would not be able to expand as a result of consumers having more incentive to save than to spend. There would be a drop in the gross domestic product of the country, affecting related businesses with not enough supply. Apart of those, unemployment rate will rises,  leading to Chinese government receiving less taxes from income tax and more expenditure on employment benefits. There is an additional social cost attached to the problem of unemployment. The social cost includes stress, anxiety, low standard of living, and many more. Lastly, the housing prices will go down when the economy reaches recession. As a result, investors will be negatively affected because they would not be receiving return in investment. As there are countless harm followed by the popping of the China’s bubble, high attention on the monitoring of China’s bubble should be placed to minimize the harm of both Chinese citizens and those around the world who would certainly be affected. This research was done using many different online sources from different parts of the world, which increases the credibility of the information being acquired. However, there are some limitations in this research as some of the numerical information present in different sites does not include a description of how or where it was acquired

x

Hi!
I'm Simon!

Would you like to get a custom essay? How about receiving a customized one?

Check it out