For years, analysts have warned of a looming real estate bubble in China, but the predicted downturn, the bursting of that bubble, never occurred - that is, until now. In a telling scene two months ago, Shanghai property developers started slashing prices on their latest luxury condos by up to one-third. Crowds of owners who had recently bought apartments at full price converged on sales offices throughout the city, demanding refunds. Sudden, steep price reductions are upending real estate markets across China. Everyone from local landowners to Chinese speculators and international investors is now worrying that these discounts indicate that "the biggest bubble of the century, " as it was called earlier this year, has just popped, with serious consequences not only for one of the world's most promising economies - but internationally as well.

What makes the future look particularly bleak is the lack of escape routes. Instead of developing a more balanced, consumer-based economy, an entire regime of Beijing technocrats - drunk on investment-led growth - let the real estate market run red hot for too long and, when forced to act, lacked the credibility to cool the sector down. That failure threatens to undermine the country's continued economic rise. Real estate woes are already sending shockwaves through China's broader economy. In a few cities, such as coastal Wenzhou and coal-rich Ordos, the collapse in property prices has sparked a full-blown credit crisis, with reports of ruined businessmen leaping off building rooftops;some are fleeing the country.

The impact of a housing downturn would also have a significant impact globally. International suppliers who have been fueling China's boom could be hard hit. Heavy losses on real estate and related lending could damage investment and consumer confidence, undermining the rising tide of Chinese demand that has been a much-needed growth engine for everything from Boeing airplanes to Volkswagen and GM automobiles to KFC and McDonald's fast food.

Understanding how this came to pass means parsing the host of distortions and mind games that characterise China's real estate market. Residential real estate construction now accounts for nearly ten percent of the country's total GDP - four percentage points higher than it did at the peak of the US housing bubble in 2005.

Chinese investors, large and small, are the ones creating the market. For more than a decade, they have bet on longerterm demand trends by buying up multiple units - often dozens at a time - which they then leave empty with the belief that prices will rise. Estimates of such idle holdings range from 10 million to 65 million homes;no one really knows the exact number, but the visual impression created by vast "ghost" districts, filled with row upon row of uninhabited villas and apartment complexes, leaves one with a sense of investments with, literally, nothing inside.

The craze for vacant real estate is due in large part to a lack of attractive alternatives. Strict controls on capital outflows prevent most Chinese citizens from investing any real money abroad. Chinese bank deposits earn very low interest rates. In contrast, real estate, which has not seen a sustained downturn since China first converted to private homeownership in the 1990s, has long looked like a sure bet.

Beijing's response to the global financial crisis added jet fuel to the fire. To maintain GDP growth of nearly ten per cent during a massive downturn in global demand, China's leaders engineered a lending boom that expanded the country's money supply by roughly two-thirds. But this run of speculation has bid up the price of housing and left people who actually need a place to live in the lurch. Given the prices prevailing earlier this spring, the average wage earner in Beijing would have had to work 36 years to pay for an average home, compared to 18 years in Singapore, 12 in New York, and five in Frankfurt.

By the spring of 2010, China's leaders were growing increasingly worried that skyrocketing prices were sowing the seeds of social unrest. In response, Beijing imposed a series of cooling measures to rein in speculative demand.

Real estate developers, however, believed they had seen this movie before. They had witnessed earlier cooling campaigns, as recently as early 2008. Each lasted a few months before reverting to business as usual. Local governments depend on a healthy real estate market to generate revenue from land sales (as the state owns the land), and property development has long been a key driver of the GDP growth that the central government both demanded and prized. So the property developers bet against cooling. They continued borrowing and building, even in the face of a relatively soft and uncertain market.

Ironically, as Chinese investors start pulling their money out of property, many are putting it into bank and trustsponsored 'private wealth management' vehicles that promise high fixed rates of return but channel the proceeds into investments - like real estate developers and local government bonds - whose returns are themselves predicated on ever rising property prices. Many fear this repackaging of real estate risk is laying the foundation for a follow-on crisis that some are labelling the Chinese equivalent of Wall Street's collateralised-debt-obligation mess.

While frightening, the popping of China's real estate bubble is not all bad news. Cheaper, more affordable housing could also unlock the savings of China's workingclass families, unleashing greater consumer demand and helping to rebalance the global economy. Investment long bottled up in idle real estate could flow to more productive pursuits. This is why at least some of China's leaders appear determined to force a correction despite the risks. But they know they are walking a razor's edge.

The writer is an Associate Professor at Tsinghua University, Beijing, Foreign Affairs