The Thicker The Tax Code, The Worse Things Get

We do not begrudge this issue much in Asia because the bulk of our tax codes are relatively simple, straight forward and with minimal rebates. We all should be very thankful for that. A number of developed countries have developed the tax code into an art form, creating legislation that evolves and multiply, so much so that they created a substantial new sub-industry in tax accounting, tax advice and compliance. 


These huge tax codes and legislations were mainly aimed at trying to better balance the avenues you get taxes from, to encourage spending and investment in certain areas, and to advance the social equality platform for various disadvantaged groups. ... And people, that is the crux of the problem, YOU DON'T USE THE TAX CODE to do the social accounting disbursements. or even to encourage various investments via tax advantageous legislations. You do that separately!!!

Why .... first if you put in a simplified code, say first for personal taxes ... RM20,000 tax free - that is a given, the initial sum to maintain your heads above poverty level. Then there should not be too many other levels above that because the more the levels, the more you encourage "BAD BEHAVIOUR" from various facets of the society. So, say RM20,001 to RM150,000 gets a 18% and above that 22%. Thats all, you will get an easy collection and verification. Try not to give rebates blah blah via taxation. The more convoluted you make it, the less effective it will be.

There are other ways to promote a reduction in social inequality, try not to do that via the tax code.


As for corporates, do a flat rate, but I would put in a low rate for the first RM500,000 so as to encourage small businesses... so it will be for profits below RM500,000 you pay 10%, any amount above that 20% flat. There will be plenty of incentives to do certain investments and deductions blah blah, and thats where BAD BEHAVIOUR arise. Just read the funny but real OZ companies' stories. My comments in red.

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When Macquarie Bank handed down its profit result the other day, there was one thing that really stood out: its humungous tax bill.

Five years ago dear old Maccas paid just 7 per cent tax. Now it pays 40 per cent, well above the corporate tax rate of 30 per cent, and up half a billion dollars in the past two years alone. That's civic-mindedness for you.
(LOL, when the tax rate is 30%, the ONLY plausible reason why you are paying 40% is you have been whacked by the tax department for under declaring in previous years, kena fined big time, or reach s settlement of sorts for certain dubious violations ... not good, but funny enough to think the mighty and bright Mac Bank with tons of smart people can end up being too smart for themselves).

We confess that we have a big mushy soft spot for this bank, especially since it rebounded with such aplomb from its near-death experience in the financial crisis. We all pitched in gladly as taxpayers, of course, backing it to raise a cool $17 billion on the bond market with our sovereign guarantees, helping it to survive and prosper.

And it has not failed us. Like any high-minded philanthropist, however, Macquarie covets a low profile when it comes to its giving. The left hand, if you like, may not know what the right hand is getting up to.

We sought comment from the bank about its elephantine tax bill but were advised chief financial officer Patrick Upfold was too busy to talk. Then we were cordially invited to ''please check any facts you want to put to us''.

There are not really a lot of facts to put. There is a thwacking tax bill of $827 million followed by two short lines of explanation: ''Rate of 39.5 per cent broadly in line with prior year due to geographic mix of income and tax uncertainties.''

Sadly, there is scurrilous chatter doing the rounds that ''tax uncertainties'' is code for dear old Maccas being rumbled by the taxman, being forced to pay penalties and so forth. Further, there are vile accusations that the bank ought to provide a little more by way of disclosure, even inform the market perhaps.
What these cynics fail to comprehend is that it is vulgar for one to boast about one's charity. Surely modesty precludes Upfold from discussing the matter since he himself has had such an intimate involvement in the bank's affaires fiscales.

Unlike credit market risk, compliance risk and other assorted risks which are reported to the bank's risk management group, tax risk sits in the financial management group, which reports to Upfold.

We will delve further into the enigmas of Macquarie's tax shortly. In the meantime, something has just come in.

News Corp artform
What a poignant moment your humble essayist has just endured, happening upon none other than the latest set of accounts for Rupert Murdoch's News Corporation.

When it comes to paper shuffling and skiving out of tax, Murdoch's faithful are without peer. They are veritable masters of origami. Like the Macquarie of yore, tax is an art-form, not an obligation.

Unlike Maccas though, News has a legion of scribes, mobilised daily across the nation, avidly issuing instructions to anybody prepared to listen on precisely how to conduct their lives. How they should vote, adore billionaires, hate greenies, you know the drill.

And at the very time we perused the News financial statements, we noticed the lead story on the News Limited websites:

''Welcome to the welfare nation: half of Australia's families pay no net tax''.

 Damn those welfare bludgers. It was blood-boiling stuff.

News deemed this tax-bludgers yarn to be so important that it even ran above the ''Nude revelry at holiday house of horrors'' story on the Daily Tele's home page.

There was video coverage, too, captioned, ''Abbott budget pain 'shared by all'''. Shared by all? Really? Shared even by Abbott's cheerleaders at News Corporation?

Casting an eye over the latest profit result, it appeared that News' revenues for the three months to March were $2 billion and its tax bill was … wait for it … $1 million.
(How can anyone get away with this, $2bn profits, $1 million taxes ... if you implemented a straight out tax rate at 20%, you would have at least gotten $400m in taxes, obviously a lot of clever shit went into it).

It gets better. Drum-roll … it actually recorded a $686 million income tax benefit for the nine months to March. How good is that! Taxpayers not only had the pleasure of sage advice from Murdoch's commentators but also the privilege of transferring $686 million of our sovereign wealth to News Corp.

Back to Maccas
Back in the day Macquarie was right in the game. In 2008 it even recorded a tax rate of 1.7 per cent after a legendary ''tax arb'' deal, a currency swap so successful it was embarrassing. It delivered a profit of $850 million in Hong Kong and a matching loss in Australia. Ergo big tax losses.
(This was so outrageous, its fixed trade between two parties with same interests).

Trouble was it also blew away a big chunk of franking credits and stuck out like a sore thumb. Since then, it has expanded further overseas, further constraining capacity to pay franked dividends.

With tax rate and franking situation, Maccas has to earn about $160 to get the return to shareholders that $100 used to make.

The bank has increased its payout ratio and it made a special return of capital from Sydney Airport. Shareholders can be well pleased, except on the issue of tax and disclosure. The combination of a 40 per cent tax rate and a 40 per cent franking has taken its toll.

As for the ''geographic mix of income and tax uncertainties'', the latter says nothing and the former has not changed sufficiently to match the deterioration in tax rate.


Read more: http://www.smh.com.au/business/macquarie-banks-humungous-tax-bill-catches-eye-20140509-380zd.html#ixzz31Swybexu

US Home Prices To Fall Still

Gary Shilling is to be respected, he has a great read on housing market in the US and has been correct for more than 20 years. If its true, basically interest rates will be kept very low for an extended period, which is good for all stocks.



Last October, when everyone was jubilant about the housing "recovery," Gary Shilling of A. Gary Shilling & Co., predicted that house prices would fall another 20%.

In the five months since, house prices have resumed their decline.

In his most recent research note, Gary sticks by his "20%" decline prediction. We've included a summary and updated charts from his argument below.

Housing: Great Expectations vs. Reality

Last spring, many believed that not only was the housing collapse over but that a robust rebound was underway. Investors were crowding into foreclosed house sales and bidding up prices in California, often the bellwether state for new trends.

The tax credit of up to $8,000 for new homebuyers that expired in April spurred buyers and promised to kick-start housing activity nationwide. TheHomeAffordable Modification Program was trumpeted by the Administration to help 3 million to 4 million homeowners with underwater mortgages by paying lenders to reduce monthly payments to manageable size and then paying homeowners to continue to make those payments.

But then a funny—or not so funny—thing happened on the way to housing recovery...

Yes, with mortgage rates so low, houses look "cheap."

With low mortgage rates and collapsed house prices, the National Association of Realtors’ Housing Affordability Index has leaped to all-time highs.

But when you don't have a job, old measures of "affordability" no longer apply...

It’s also become clear that the NAR’s Housing Affordability Index in the earlier post-World War II years is not relevant to today’s conditions. Back then, unemployment rates were usually much lower than now and the current threats of layoffs, wage and benefit cuts and being forced into part-time jobs were almost nonexistent. Who ventures into homeownership if he doesn’t know the size of his next paycheck or even if he’ll have one?

Also, with almost a quarter of all homeowners with mortgages under water with their mortgage principals exceeding the value of their houses, many can’t sell their existing abodes even if they wanted to buy other houses.

Unemployment is declining, but job growth has hardly been robust

Mortgages delinquent 30 days, many of which will probably end in foreclosure, have risen lately. They peaked in the first quarter of 2009 at 3.77%, then fell to 3.31% at the end of 2009, but have since risen to 3.51%, according to Tom Lawler.

He goes on to observe that 30-day delinquencies are linked to initial claims for unemployment insurance, which fell last year but subsequently leveled off and are now rising. Also, the delinquencies are rising as weak borrowers with modified loans again miss payments. Fitch Rating believes that 65% to 75% of mortgages modified under HAMP will redefault within 12 months.

And the number of people unemployed per job opening is coming down, but it's still very high

And those who are unemployed have been unemployed for a very long time

True, there are some hopeful signs. The percent of mortgages past due has begun to fall...

And, last spring, thanks to the tax credit, sales of existing homes skyrocketed. Alas, the effect was temporary.


The revival of home sales early [last] year proved to have less follow- through after the tax credit expired in April than did the previous expiration last November.

Existing home sales subsequently fell to a new low, so the tax credits had only “borrowed” sales from future months with no lasting impact.

And since last year's happy uptick, prices have begun to fall again...

Most importantly, the number of houses for sale is still abnormally high... and house prices, like everything else, are a function of supply and demand.

As we’ve stated repeatedly in many, many past Insights, excess inventories are the mortal enemy ofhouse prices. And those excess inventories are huge.

Notice that, over time, new and existing inventories listed for sale have averaged about 2.5 million. So, we reason, that’s the normal working inventory level and anything over and above 2.5 million is excess.

At the peak of 5 million reached in October 2007, that excess was 2.5 million. It subsequently fell but with the recent jump, the total is 4.0 million, implying excess inventories of 1.5 million.

That’s a lot considering the average annual build of 1.5 million houses. So the inventories over and above normal working levels equals one year's average demand. But wait! There’s more!

As noted earlier, as foreclosures pick up with the ending of the mortgage modification-related moratorium on lender takeovers, “shadow” inventory will become visible as many of those bereaved of their abodes join friends and family.

Furthermore, if we take the Total Housing Inventory numbers published by the Census Bureau at face value—and Tom Lawler, a very careful housing analyst concludes that it takes more than the faith of a mustard seed to do so—there are a lot ofhousing units that are likely to be listed for sale as owners give up trying to wait out the housing bust.

Recently, my wife told me of a friend who finally listed her house for sale right after Labor Day and got nary a nibble in the following three weeks. Then she was further discouraged when two other similar houses in her neighborhood were listed.

And then there's the "shadow" inventory--including the still-massive number of foreclosures.

The Administration’s HAMP initiative, introduced in April 2009, has been a huge disappointment...

But while mortgage modifications were attempted, lenders and servicers were basically forced by the government to suspend foreclosures. Now, as that program unwinds, foreclosures will again jump. Ironically, foreclosure rates have moderated recently because lenders tightened their standards in mid-2008 when housing and mortgages were in free fall. In 2009, two-thirds of all FHA- guaranteed new loans were to borrowers with credit scores over 660, up from 45% in 2008.

Nevertheless, lenders have been loosening in recent months. In January, Fannie initiated a program that allows first-time homebuyers to put down $1,000 or 1% of the purchase price, whichever is greater. In the first half of this year, credit card companies sent out 84.8 million offers to American subprime borrowers, up from 43.7 million a year earlier. In the second quarter of this year, 8% of new car oans were to borrowers with the lowest rank of credit scores, up from 6.2% in the fourth quarter of 2009.

And bank-owned houses (more future inventory)

Already, Real Estate Owned by lenders due to foreclosures—perhaps the most hated term among bankers—is climbing. Estimatesare that a major share of the 7 million houses that have delinquent mortgages or are in some stage of foreclosure, as well as those yet to come, will be dumped on the market, adding to the already huge excessive inventory glut. Some 4.5 million loans are now in foreclosure or at least 90 days delinquent.

And the folks who aren't selling because prices are still weak

Between the first quarter of 2006, the peak of house sales, and the second quarter of this year, the number ofhousing units, net of teardowns, conversions to non-housing uses and other removals, rose 5.7 million.

Of that total, 1.1 million were added to the pool of vacant units listed for rent or sale, 2.8 million were occupied by new households and so on down the list. Of the 1.3 million increase in those Held Offthe Market, the 1.1 million rise in the “Other” category is the one of interest. This component has leaped from the earlier norm of about 2.6 million to 3.7 million in the second quarter.

This rapid rise, coinciding with the collapse in housing, suggests strongly that many of these houses are indeed shadow inventory, units withheld in hopes ofhigher prices but highly likely to emerge from the woodwork sooner or later.

If we assume that half the 1.1 million increase since the housing peak in the first quarter o f2006 are shadow inventory, the total excess jumps from 1.5 million to 2 million at present, and is likely to rise further.

So, the question is, how long will it take us to absorb all that excess inventory? Some analysts think 1-2 years. Gary Shilling thinks 4-5 years. Why? First because household formation is still lower than it was during the boom

Many believe that household formation and, therefore, demand for either owned or rented housing units is closely linked to population growth. A Beazer Homes official said recently that demographics would normally produce household growth of around 1.5 million a year.

But note that those trendless series are extremely volatile, ranging from a peak of almost 2.3 million at annual rates in the current cycle to less than 500,000 recently. Household formation is similarly volatile, not surprising since a household is defined as one or more people living in a separate dwelling unit and not in jail, college, an institution or an army barracks. So household formation is affected by the lust for house appreciation, income growth, employment prospects, family size, mortgage availability and all the other factors that determine the desirability of owning or renting.

The homeownership rate (percent of households that are homeowners) continues to decline, probably headling back to its long-term average.

Back in the salad days of 10% annual price appreciation, a homeowner and/or investor who put down 5% enjoyed a wonderful 200% return on his investment per year, neglecting taxes, interest and maintenance. But that hapless homeowner who bought at the peak lost all of his downpayment six times over as prices fell 30%.

No wonder that the homeowner rate, which spurted from its 64% norm to 69%, is now back to 66.9% in the second quarter and probably on its way back to 64%.

More people are choosing to live with their parents. As they lose their jobs and houses, many Americans are "doubling up"--moving in with friends and relatives. This further reduces demand for housing.

Of course, homeowners thrown out of their abodes by foreclosures can continue to be separate households
by renting houses and apartments, but many of those and other discouraged folks are shrinking
households—and adding to vacant housing units—by doubling up with family and friends.

The Census Bureau reports that in the last two years, multi-family households jumped 11.6% while total households rose a mere 0.6%. Those aged 25-34 living with parents—many of them “boomerang kids” who have returned home—increased by 8.4% to 5.5 million. Not surprising, 43% of those were below the poverty line of $11,161 for an individual.

And now everyone knows that house prices CAN actually fall, so they're no longer rushing to get in on the the most amazing investment ever.

Most of all, the NAR’s Housing Affordability Index is largely irrelevant today because in contrast with the earlier post-World War II years, prospective buyers know that house prices can, and do, fall.

Who wants to buy an expensive asset with a big mortgage that may be worth much less shortly? And the financial leverage created by a mortgage magnifies the risk tremendously. Someone who buys a house with 5% down sees their equity wiped out if the price falls only 5%. So the fall in house prices and mortgage rates, which have driven up the NAR’s measure of affordability, have been offset by stronger forces.

So, too, will any future increases in the affordability index in all likelihood. The Fed may embark on further purchases of mortgage securities, which could reduce mortgage rates further, but the central bank will probably only act in response to additional economic weakness that will discourage homebuyers. The further declines in house prices we foresee will make them cheaper, but also convinces prospective owners that they are even worse investments.

The rebound in house prices is also suspect and may have peaked out. Furthermore, both the previous decline and subsequent reversal probably overstate reality. Earlier, the many sales of foreclosed houses or by distressed homeowners tended to be lower-priced houses and, therefore, depressed average prices. The recent swoon in Los Angeles house prices compared with the early 1990s drop suggests this is true. Conversely, the recent rebound may be overstating reality since, as our good friend and great housing analyst Tom Lawler has noted, the homebuyer tax credit may have induced some to pay up to beat the deadline and to favor higher priced “traditional” house sales over “distressed” homes.

Tom also points out that the Case- Shiller price index for July, which showed increases in 13 of the 20 metro areas (not seasonally adjusted), was based on transactions from April to June and, therefore, included tax credit- related settlements in May and June. Also, seasonally-adjusted data reveals declines in 16 of 20 metro areas and a small 0.1% fall from June to July. Another Home Value Index compiled by Zillow reports that prices nationwide fell in July from June, the 49th consecutive monthly fall. That puts them down 24% from the May-June 2006 peak, similar to the 28% drop in the Case-Shiller index.

On a positive note, housing starts are still at a startlingly low level, which means less new inventory to absorb.

THE BOTTOM LINE: Gary Shilling thinks house prices probably have another 20% to fall.

This huge and growing surplus inventory of houses will probably depress prices considerably from here, perhaps another 20% over the next several years. That would bring the total decline from the first quarter 2006 peak to 42%.

This may sound like a lot, but it would return single-family house prices, corrected for general inflation and also for the tendency of houses to increase in size over time, back to the flat trend that has held since 1890.

We are strong believers in reversions to the mean, especially when it has held for over a century and through so many huge changes in the economy in those years—two world wars and the 1930s Depression, the leap in government regulation and involvement in the economy, the economic transformation from an agricultural base to manufacturing and then to services, the post- World War II population shift from cities to suburbs, the western and southern transfer of population and economic strength, the movement from renting to homeownership and the accompanying spreading of mortgage financing, etc.

Furthermore, our forecast of another 20% fall in house prices may be conservative. Prices may well end up back on their long- term trendline, but fall below in the meanwhile. Just as they way overshot the trend on the way up, they may do so on the way down, as is often the case in cycles. Furthermore, another big house price decline will spike delinquencies and foreclosures leading to more REO sales by lenders,whichwillfurtherdepress prices. Our analysis indicates that a further 20% drop in prices will push the number of homeowners who are under water from 23% to 40%, resulting in more strategic defaults, more REO, etc.

Even prices in New York City have resumed their fall!

If house prices DO fall another 20%, a lot more homeowner equity will be wiped out. And that's not good news for banks. Or the economy. Or, for that matter, future house prices.

At that point, the remaining home equity of those with mortgages would be wiped out on average. That, in turn, would impair already-depressed consumer confidence and their willingness and ability to spend, to say nothing of residential construction.

In California, epicenter ofthe housing boom-bust, construction jobs dropped 43% from June 2006 to June of this year, compared to a 28% decline nationwide, and the unemployment rate in the Golden State jumped to 12.3% in June, far above the 9.5% rate nationally.


The essay was excerpted from the latest monthly research of Gary Shilling of A. Gary Shilling & Co.

Roubini On Malaysia

Malaysia's policy makers have been forced to confront the factors blocking the country’s rise to high-income status. Facing higher labor costs, the economy has been unable to maintain a growth model based on low-value-added manufacturing that was largely successful for the 30 years prior to the 1997 Asian financial crisis.



One of the most noticeable manifestations of this so-called middle-income trap has been the secular decline of Malaysia’s once-dominant electronics and electrical products (E&E) sector, examined in “Still Not a Tiger: The Decline of Malaysia’s Electronics Sector,” available exclusively to clients. At the sector’s height in 2000, E&E accounted for more than one-third of the country’s total value added in manufacturing, over 70% of revenue from manufacturing exports and almost 4% of world E&E exports.

Since then, Malaysia’s E&E sector has witnessed dramatic deceleration in productivity, stagnation in exports and deterioration in its global market share. The sector remains dominated by downstream industries that increasingly face competition from lower-cost producers in the region, including the Philippines and China. Confronting similar challenges, the Asian Tigers (South Korea, Singapore, Taiwan, HK) were largely successful in transitioning to higher-value-added E&E production.

Beginning in the 1960s, Malaysia and Singapore (and, to a lesser extent, Taiwan and South Korea) industrialized by encouraging multinational corporations to take advantage of their relatively cheap labor forces and establish downstream E&E production facilities. In Singapore in particular, the presence of multinationals spurred local entrepreneurs to begin “clustering” around downstream enterprises, acting as suppliers and logistics managers.

Over time, this led to the development of a robust, indigenous E&E sector that increasingly produced further upstream, which typically included the stages in the supply chain in which labor adds more value—i.e., the stages with higher levels of labor productivity. By the time labor cost increases forced downstream production facilities to lower-cost markets, local firms were experienced and competitive enough to continue operating in the E&E supply chain at higher levels of value added. In this way, Singapore has managed to increase its global market share of E&E since 2000.

In contrast, Malaysia’s E&E sector has been unable to adjust to shifts in the country’s comparative advantage. One important barrier has been ethnicity-based affirmative action policies, which have stifled the evolutionary process that other export-driven economies in the region were able to ride to higher-value-added production on their way to high-income status. Established under the New Economic Policy of 1971, affirmative action in Malaysia seeks to rectify socioeconomic disparities within the local population by expanding opportunities for ethnic Malays (bumiputra or bumiputera) in areas like education, housing and investment, often at the expense of other ethnic groups (namely ethnic Chinese).

These policies have not only exacerbated the country’s brain drain of talented non-bumiputra; they also have created a strategic disadvantage for local firms by limiting both human and Financial capital and perpetuating an unlevel playing field for entrepreneurs. All domestic companies incorporated in Malaysia must reserve at least 30% of new shares for bumiputra to purchase at discounted prices. This essentially taxes local start-ups that wish to go public and makes expansion more difficult, which helps explain why initial public offering growth was relatively flat through the 2000s and why equity remains a minor source of manufacturing investment financing. Meanwhile, the continued presence of the government in the economy—via procurement policies and access to joint ventures with the nearly 500 government-linked corporations—has provided ample opportunity for rent-seeking by well-connected bumiputra who can take advantage of favorable policies.

The New Economic Model—presented in 2010 as a 10-year vision for Malaysia’s ascension to high-income status—proposes “revamping” affirmative action “to remove the rent seeking and market distorting features” and shifting the basis for eligibility to socioeconomic status, rather than ethnicity.

Yet given the governing party’s reliance on bumiputra support, major changes are unlikely until new elections are held and the government has the political confidence to confront popular resistance to reform. The underperformance of the E&E sector over the past 10 years should serve as a warning to the country’s policy makers that the continuation of distortionary policies may limit Malaysia's future growth prospects.

Andy Xie Is Spot On On China Property

By Andy Xie

The central government has unleashed another round of property tightening measures. This time it is focusing on mortgage lending terms: the mortgage interest discount for first-time homebuyers has been reduced; the discount for second-time homebuyers has been abolished and the down payment requirement raised to 40%; and the rate for third-time buyers is being left to the banks' discretion with down payments raised to 60%.



Predictably, sales volumes in both primary and secondary markets have collapsed. But no one is panicking, not even those who live off the property bubble. Why? Aren't they supposed to be terrified of the government's crackdown?

It seems we have seen this movie before. China has launched property-tightening measures several times but it relaxed them just when they began to bite. The bottom line is that local governments, and the central government through them, depend very much on property for revenue. The market doesn't believe the government will cut off the hand that feeds it.

Local governments and developers are sitting on massive liquidity that they raised last year through land and property sales and borrowings, taking advantage of the "anything goes" window during the stimulus period. They seem to believe that the central government will change its mind before they run out of liquidity. So they are comfortable waiting and not cutting prices.

Cutting prices doesn't make sense if the government is expected to loosen policy again soon. The current lending terms effectively keep second- and third-time homebuyers out of the market. To sell, developers must cut prices to levels affordable to the buyers of first homes, who have low incomes and little wealth. All the players will play by the new rules only if the central government proves its credibility by maintaining the tightening policy until local governments and developers run out of money.

Contrary to the policies' intent, local governments are readying for another round of property inflation. Local governments have been using bank loans to resettle residents, and resettlement costs have skyrocketed since those being moved need enough compensation to buy properties at today's prices. Unless property prices rise considerably, local governments will end up losing money, which they cannot afford to do.

Resettlements played an important role in supporting demand for property last year. The overwhelming majority of end-user purchases probably came from resettled residents who used their compensation money for a down payment. Resettlement compensation is the biggest transfer of wealth from the government to the household sector since the privatization of public housing at low prices a decade ago. It is probably the most important government action supporting today's economy.



The positive elements of resettlement compensation come with two major negatives. First, it is using a form of leverage to support demand. Local governments borrow to pay the compensation packages, using the land as collateral. The resettled residents use the compensation as down payment for mortgage borrowing; so government debt becomes equity for mortgage debt. There is no real equity in the financing chain.

Second, the high compensation costs, though beneficial to the resettled residents, make local governments a player in further inflating property prices. China's economic policies have been favorable to the low-income class in the past few years through rural subsidies, agricultural land reform, and price controls for necessities. The resettlement policy is another element in the push to help them, but the costs are being borne by the middle class, whose most important expenditures — property, cars and education — are highly inflated. Indeed, China's property and car prices are among the highest in the world in absolute terms, and by far the highest relative to income. Unless policies change dramatically, the middle class squeeze will only get worse.

China's property market is a massive bubble. The stock of residential properties, developers' inventories, and land that local governments have pledged to banks may exceed by three times the gross domestic product. Rental yields in most cities are too low to cover depreciation costs. In major cities, the price-to-income ratio, a measure of housing affordability, is routinely above 20, which means that it would take an average mainlander 20 years to buy the average property using their total income. The bubble can still continue because China's banking system has plenty of liquidity – thanks partly to hot money and because local governments have many levers to channel bank liquidity into the market. But the longer the bubble lasts, the more damage it will do to the economy.

The stability of a modern society depends on its middle class being in the majority and content with its situation. The high land-price policy is a form of tax on the middle class, which will slow its growth. China may become a country with a small group of the super-rich, a vast lower class with no property, and a small middle class. Such a social structure would not be good for long-term stability.

The key to a sensible property policy is to reform the fiscal structure. First, government spending, mostly in fixed investment, should be curtailed. China doesn't need to build everything at once. Last year, the sum of government fiscal revenues, central and local government borrowings, and expenditures by state-owned enterprises probably exceeded half of the GDP. Could the government sector spend so much efficiently? Shrinking the government sector should be a top priority for the nation's future.

Second, the government sector still owns assets worth more than the entire GDP. The government should give it to the people to expand the middle class – a move that would support consumption, incomes and tax revenue. Shrinking the government and giving wealth to the people are the policies necessary to make growth balanced and sustainable. The rapid expansion of the government sector only increases its need for revenue and the incentive to inflate the property bubble. Without credible government reforms, property tightening is not credible.

One more point to note is that most of the bears assume Beijing will be sitting around doing nothing. Please note that bank lending by Chinese banks fell 43 per cent in the first quarter from a year earlier as the government winds down its stimulus and tries to cool a credit boom while keeping its recovery on track, central bank data showed on Monday.

Banks lent 2.6 trillion yuan (S$529.7 billion) in the January-March quarter, the People's Bank of China said on its Web site. That compared with 4.6 trillion yuan in loans in the first quarter of 2009 as banks ramped up loans for construction and other projects as part of a 4 trillion yuan stimulus. The figures indicated the central bank's efforts to prevent runaway lending and restore financial discipline in China's state-owned banking industry might finally be taking hold, lessening the need to raise interest rates to curb inflation.

The tightening on lending reflects worries that many of the loans issued in the past year or more may go sour and that easy credit is fueling wasteful investments. On Sunday, the chairman of the China Banking Regulatory Commission, Liu Mingkang, announced an aggressive plan to assess the safety of loans made to financing entities set up by local governments to invest in real estate, infrastructure and other projects.