This past April, after several years of unprecedented appreciation in property prices throughout the major cities of China, the government finally stepped in and introduced measures to curb the speculative buying that is largely to blame for the current housing bubble. The regulations bumped the down payment on second-home mortgages to at least 50 per cent of the total price and instructed banks to significantly tighten housing credit for anyone buying a third home. Since these policies have been in place, sales volumes have plunged and price growth rates have slowed, however housing prices have not yet started to fall.

Over the past few years the property market has been a key factor in helping China avoid the worst of the global recession, easing some of the pain the country suffered from a decrease in exports. Export volumes have failed to bounce back as quickly as initially projected due to both the EU’s current debt crisis and the United States’ sluggish recovery. With very little else to invest in, people have been pouring hot money into property in hopes of quick returns in a market overwhelmed with runaway appreciation. A local realtor, who wished to remain anonymous, believes, “Much of the newer property coming to the market is about 30 per cent overpriced due to speculative demands.”

“I believe it will cool off, but it is hard to contain a market that has constant demand for property and a lot of cash on hand with nowhere else to put it.”

Presently, Beijing faces a predicament – a choice between easing the bubble and dramatically cooling off the economy, or facing the possibility of a collapse and resulting financial crisis. The property market drives large swathes of the economy by supporting the construction, steel and concrete industries. Furthermore, many local governments depend on land sales and development projects for income – without continuous inflation in the property market, many cannot afford to pay back the bank loans on these costs. Both property developers and local governments are hoping the recent policies are reversed or eased before their liquidity runs dry.

Andy Xie, an economic analyst for Caixin Online, says, “The issue is the credibility of the policy. Speculative demand is due to the low interest rate. On the supply side, local government dependency on property for revenue is the driver. The current policy tries to identify speculators and keep them out of the market. Developers don't think the current policy is sustainable, hence transaction volume is down two-thirds but price has barely budged. They are waiting for the policy to change back.”

Whether this will happen remains to be seen. Many industry insiders believe Q3 2010 will see a 10 to 15 per cent price correction, yet this could be only a temporary change until the psychological impact of the regulations wears off and speculative investment begins again. But Xie believes even this adjustment is not enough. “Without a big price correction, it's hard to see normal demand appearing. Presently, the average housing price in Shanghai is ten months of average salary after tax – an 80 square metre flat costs nearly 68 years of income.”

The local realtor concurs with his assessment, “I believe it will cool off, but it is hard to contain a market that has constant demand for property and a lot of cash on hand with nowhere else to put it; I think prices will be 40 per cent higher within the next five years.”

Other countries have experienced similar property bubbles before, including Japan in the late 1980s and the United States just two years ago – one that ended in global recession that has yet to dissipate. China’s options for staving off disaster are limited. It will need to continue to keep hot, speculative money out and may be forced to introduce a property tax. Nobody can predict for certain what will happen, however if the bubble pops, China could plunge into financial crisis, which in turn would dramatically affect the global economy.