China/Jenga
With the world’s second-largest economy, what happens in China has the potential to reverberate around the globe. That’s why so much attention is being paid this week to China Evergrande Group, aka Evergrande, an enormous Chinese real estate corporation that’s teetering on the brink: Although its $300 billion in debt is a relative drop in the bucket on a global scale, whether this is the first domino to fall in a larger economic reset is the point that has analysts on edge.
Let’s take a look.
Why Evergrande matters globally
At the start of this week, when reports re-emerged that Evergrande — China’s most heavily indebted private-sector property developer — was likely to default on some very large payments, markets around the world shook.
Still, analysts said, it was unlikely that China’s leadership would allow such a massive failure: Dipping toes in capitalism with the goal of a socialist nation has brought about enormous wealth for hundreds of millions of Chinese citizens. (And it has also brought on equally enormous disparities, an issue that President Xi Jinping is hoping to stem through the country’s “Common Prosperity” initiative.)
China’s richest 20% earn more than 10 times the poorest 20%, a wider gap than in the U.S. or European countries such as Germany and France, and one that hasn’t budged since 2015. Though the number of people living in extreme poverty has dropped dramatically over the past decade, more than 600 million people — about half of China’s population -- live on an annual income of 12,000 yuan ($1,858) or less. At the other end of the spectrum, rapid economic growth and market-based reforms created tremendous wealth: China has 81 billionaires on Bloomberg’s ranking of the world’s 500 richest people, more than any other country after the U.S., and there are thousands more billionaires and multimillionaires who don’t crack the top 500.
Back to Evergrande, though.
Fast forward to today when the investment world awaits word on whether Evergrande will default on a roughly $84 million interest payment. Add to the uncertainty that this morning, the Wall Street Journal is reporting that China may opt not to bail out Evergrande after all and, instead, is preparing the country for potential fallout.
As also reported by WSJ, some of the issues that Evergrande faces may be tied, at least in part, to recent policy changes by the government, including property-ownership limitations and a call for developers to deleverage. And here’s what’s got people a bit tense: the dichotomy between the economic growth that real estate development fosters and the eventual challenges that result, not the least of which becomes affordability:
Real estate directly accounts for 7.3% of national gross domestic product, according to official figures, though analysts say that real estate and real-estate-linked industries collectively drive nearly one-third of economic output.
China has struggled for years to calibrate its housing policies. Prices have marched steadily higher in the years since the real-estate market was liberalized more than two decades ago. In recent years, prices had risen out of reach for many households, raised corporate and household debt levels and sparked concerns about a debilitating burst bubble.
In recent months, stabilizing the market has become a priority for leader Xi Jinping, with officials repeating the mantra: “Homes are for living in, not for speculation.”
Political and economic frameworks aside, then, China’s challenges, then, aren’t altogether unfamiliar to the rest of us.
In another WSJ piece, “Evergrande is China’s Economy in a Nutshell,” James Mackintosh writes:
If China really is pushing back against unsustainable debt-driven growth, it faces a series of tricky problems as it remakes its economy. It will have to wean the population off the idea that empty apartments are a good vehicle to save money, without destroying everyone’s savings. It will have to persuade people that they should save less and spend more. It will have to reallocate vast numbers of workers and capital from real estate and the broader construction industry, which together make up about one-eighth of the economy, and together with suppliers probably account for more than a quarter of gross domestic product. And it will have to raise taxes to substitute for land sales as a source of finance. Worse, it will have to do all this while adding less debt and accepting a lower growth rate.
And as uncertainty rules, Evergrande surges and dips
As has become all-too-familiar in the markets these days, as uncertainty rules for one of China’s largest property developers, as of the time that I write this, Evergrande’s stock is fluctuating wildly, from early-morning surges to late-morning dips and, by the time this post goes live, possibly back and forth dozens of times, signaling once again the gamification of the markets that has been so prevalent these last couple of years:
Will capital flight be further curtailed, too?
In my opinion, capital flight out of China into the US shouldn’t be a surprise: As I see it, humanity will always gravitate to freer movement of capital, wealth, creativity and thought. With President Xi leading the way to a more socialist path — albeit via “temporary capitalism” — people and money will find elsewhere to go if they feel that their fortunes (or savings) are at risk.
People’s lives and livelihoods are vulnerable when economies suffer massive fallout (ala, the U.S. post-Lehman). We learned a hard lesson back then and that’s why so many economists and investors and everyday people are on tenterhooks, waiting to see what Evergrande and the Chinese government will or won’t do.
As reported in several news outlets, it looks like President Xi is advising local leaders to take it into their own hands to figure out what the potential ramifications are and how to quell unease and protests.
Much like Jenga, major economic powers are a delicate balancing act of investment, debt, diversity, profit, innovation and the like, all built on a foundation of belief in the governmental system providing the support. As we’ve been reminded several times over the last handful of months, though, at the end of the day, the Chinese system is one of communism, not capitalism, albeit one that has benefited enormously from capitalist hallmarks of innovation and creativity.
Given this, will China’s system stumble, tumble or simply wobble? We should know more before long.
Original photo by Alena Darmel from Pexels
Are markets itching for a reset?
For the last several years, and as I’ve covered extensively in this blog, the markets have been wild, and wildly climbing. While no one wants an economic meltdown on the scale of the Great Recession, a lot of economists and investors alike are looking for issues, like Evergrande, to see if there’s the potential for a bit of cooling.
After reading the tape this week, if that was to be the case, maybe it wouldn’t be a terrible thing, as the markets have run too hot to continue at this pace and valuation. As for all of us who have bought in on this roller coaster ride, buckle in.
Stay safe and healthy. Talk to you next week.
