Chinese Property Crisis Inbound: The Impact a Chinese Economic Collapse will have on International Markets
Having written and edited the second book in the ‘Essays’ series, a few articles touched very briefly on the Evergrande crisis. It was mostly done in passing to make a point about planning economically for the future and giving a bit of foresight on to the modern economic market, but as of writing this, news has just reached the shores of western media that Evergrande has officially defaulted. So allow me to give you the run down over the last four months of the slow train crash has begun to pick up speed and will likely start us off in the first quarter of 2022 with a literal bang.
Thoughts of a Depression — The Inaugural Article born from a Chinese Market Crisis
Yes, the Chinese property behemoth has imploded in on itself with a whopping $300bn worth of liabilities on its balance sheet, and is showcasing how the Chinese model of communist capitalism (do I get an award for most ironic yet hilarious statement this year?) is where caution can be thrown to the wind regarding governance and risk, as the property developers believe, much like those on the Chinese trading floors, that big daddy government will come to the rescue if needs be. It is this form of market economy that is mimicking that of 2008 but on a much more explosive scale.
Yes, the chances of this news being kept under wraps to prevent panic and to allow for the big financial players to offload any worthless “assets” they may have on the books, to position themselves much better going into a possible depression, is highly likely. Which leads to questioning and an understanding of how big and pivotal this current situation actually is in regards to the future of economic welfare around the globe.
Yes, the chances of the big property players along with Evergrande, like Fantasia (Defaulted: 5/10/2021), Sinic (Defaulted: 20/10/2021), or Modern Land (Defaulted: 26/10/2021), defaulting have been happening and are also going to happen , which will take out a whole sector that has been built on speculation and debt. This speculation and debt has contributed to the property sector in China accounting for the whopping total figure of 29% of Chinese GDP (according to Kenneth Rogoff of Harvard and Yuanchen Yang of the IMF, 2020).
When a company like this can’t afford to pay back bond coupons worth $82.5mn (09/12/2021) or $150mn (11/10/2021) you know something is up. When a company like this sees shares absolutely bottom out continually and force trading floor closures for days, or when nobody wants to step up and buy out parts of the company ($1.7bn for Hong Kong HQ 16/10/2021) that are being sold, this is massive cause for concern, especially when looking at the kind of signaling that is putting out into the market.
Not to mention that all of the above does not help the inevitable of what is to come when Chinese state media has been blatantly lying when it said on the 20/10/2021 that the missed bond payment of $80+ million was made to Citibank when it indeed was not, as publicised by the Financial Times on 9/12/2021.
With the basic overview out of the way, lets dive into the dirt a little bit more and look at the impact the Evergrande default will have on global markets.
The Primary Problem — The Economic Crisis that’s Coming due to Evergrande
Let’s go back to basics here and list the two main factors that are the main problems that are going to destroy the Chinese economy as well as the knock on effects to destroy world economies as well; those being the risk from overleverage and the risk of currency.
As outlined before, the balance sheet for Evergrande has $30bn in assets while it has $300bn in liabilities. They have been consistently unable to pay the couple million owed in bond coupons to those who have bought their corporate bonds of whatever yield and time frame they were issued at. This super charged form of leverage that has helped in the Chinese property bubble has come about thanks to the communist capitalism (yes, I laugh every time I write that as I do not have another word to succinctly define their market situation yet) they are practicing that imposes phenomenally strict limitations on those who can and want to invest in equities, but when it comes to real estate investment the same potential investors that can’t put capital into equities have little to no impositions when it comes to the housing market.
So, if those who want to invest for the future are looking to put money into what is open to them (especially with a fast growing middle class in China) then the money will end up in the real estate markets and not in equities. This has funneling of funds into this one avenue of investment which has artificially inflated demand and by extension, prices of housing. This is very much like what is going on in Ireland at the moment, but that has been written about at length in previous articles. Now, unlike Ireland, the Chinese construction companies have used this artificial inflation of prices to take out equity for lending, thus allowing the funding of more and more projects. Just focusing on the Chinese economy at 29% coming from real estate, Evergrande accounts for 2% of that and when a single company has that kind of clout on an economy, if things go bad, they go bad fast.
The next question that should be on your lips after reading that is, how does a property sector default, that accounts for 29% of the worlds 2nd largest economy, affect the rest of us in the international market?
It is not weird for companies to raise capital by selling highly rated investment grade bonds for medium to long term, or the selling of short term commercial papers. However, knowing now how the Chinese property bubble was being blown up, this is a very unstable foundation for long term investment and is highly risky, so what did large banks and investment institutions do on the good faith from the Chinese property players? Well, they bought up the bonds and papers, and not only did they buy up the bonds and papers, they repackaged them, they got them rated, and they put them out to the market to be sold. This is literally the exact same thing that caused the 2008 market crash with collateralised debt obligations (CDO) but now they had a “made in China” stamp on them. All of this was done on the premise that the Chinese government would step in to save any potential risk of default and guarantee the repayment of the bonds and papers. The obligatory telling you the reader to watch “The Big Short” for how CDO’s work is a must for any economic or finance hobbyist as it is pertinent to this article.
This rickety foundation the bonds and papers were built upon only needed some internal information to get loose, about the problems with the balance sheet, into the market for investors to begin offloading and thus impacting grading and share price, both of which we see becoming junk and almost worthless. To cover any exposure, those that have been holding these CDO’s, bonds, or papers, will offload as much of the poison as possible onto unsuspecting and naïve buyers. Not being worth the paper they are written on, junk can’t be used as collateral in dealings, and in the rush to sell to find cash, a hell of a lot of liquidation will be happening in an attempt to survive. This is where I will plug the film “Margin Call” to those that are interested in how fire sales and margin calls are conducted on Wall Street but with all the Hollywood pizzazz attached.
Basically, any firms with exposure will offload as soon as possible to shore up the incoming market turbulence down the road. Those firms that are late to save themselves will go bust, and any firms that have been invested in them will need to limit exposure, recall debt, and sell off NPL’s and other measures of that nature. Do you see the cycle that is forming here?
The Fan is about to be Hit by Something and it Stinks
Any sort of exposure or exposure to affected firms, will see this contagion effect sweep through the global markets and kill any firms that are not equipped or smart enough to protect themselves. This is going to be 2008 but far worse and damaging, but hey, maybe if you’re in these too big to fail firms you’ll be looked after as champagne socialism is good when times are bad for you, even though total free market espousal is the raison d’être when you can financially bully other up and coming firms that cause you competition.
With the $300bn at the face value of the liabilities about to be wiped off the balance sheets of firms around the world, and as bankruptcy has been declared, proceedings should take between 30 days and 2 months to be completed according to the Cayman Island Bankruptcy code after a decision is made in court. So 2022 is the year the dragon may die, unless something extraordinary happens. Look after yourselves and your loved ones, times are going to get tough and we don’t even know how bad.