Blain’s Morning Porridge – September 21 September 2021: Is Evergrande a symptom of deeper malaise?
“If that’s true, we are very close to the China Syndrome ”
This Morning – Evergrande’s imminent default is rocking markets – but few believe the collapse of a Chinese property developer could trigger a global financial crisis. What if Evergrande is just a symptom of a deeper malaise within the Chinese economy and its political/business structures? Maybe there is more at stake than we realise? What if Emperor Xi decides he needs a distraction?
After yesterday’s market tumble Evergrande dominates thinking this morning. The early headlines say the risk is “easing”. Don’t be fooled. S&P are on the wires saying it’s on the brink of default and is unlikely to get govt support. It’s Asia’s largest junk-bond issuer. Anyone for the last few choc-ices then?
The market view on the coming Evergrande “event” is mixed. Some analysts are dismissing it as an internal “China event”, others reckon there may be some systemic risk but one Government can easily address. There is some speculation about “lessons” to be learnt… There are even China supporters who reckon its proof of robust China capitalism – the right to fail is a positive!
I’ve got a darker perspective.
The massive shifts we’ve seen in China’s political/business public persona over the past few years have been variously ascribed: a reaction to Trump’s protectionism, China taking its place as a leading nation, Xi flexing his military muscle, and now a clampdown on divisive wealthy businesses to promote common prosperity.
What if Evergrande is just a symptom of something much deeper? That that last 30-years of runaway Chinese growth has resulted in a deepening internal crisis, one that we barely perceive in the west? What if the excesses that have spawned Evergrande and the illusion every Chinese can afford luxury flats and a western standard of living is about to implode? Crashing oriental minor chords!
The looming Chinese property debacle will be fascinating, but it many respects will be similar and yet very different to the multiple market unwinds we’ve seen in the west. How it plays out will have all kinds of implications for growth, speculation and how global investors perceive China in the future. Folk are variously describing it as China’s Lehman Brothers, or the next “Minsky Moment” when speculation ends with a sharp jab of reality to the kidneys.
I’m thinking back to a story I read a few years ago about the Shanghai Auto-fair pre-pandemic. Evergrande New Electric Vehicles had the largest stand and was showing off 11 different EVs. Not one of these were actually available to buy – they were all models of as-yet unproduced cars. The company was valued at billions and yet never sold a single vehicle. This morning, it’s just another worthless business Evergrande is trying to flog. (See this story on Bloomberg TV: China’s Zombie EV Makers.)
The market is asking itself a host of questions about Evergrande’s collapse: How bad will its tsunami of Chinese contagion deluge global markets? When it’s going to happen? What knock-on effects will cascade through markets?
Perhaps the most important question is: Who will be exposed “swimming naked” when the Evergrande tide goes out? Who will be left with the biggest losses? As the company is definitely bust, these losses rather depend on just how China’s authorities respond.
Step back and think about it a moment – try putting these in context:
- Fundamentally all business is about identifying a consumer need and filling it.
- Fundamentally, greedy businessmen tend to get carried away because the political-financial system enables them.
- Fundamentally, it’s just another burst bubble and who cleans up the mess.
- In Evergrande’s case a thousand flowers of capitalism with Chinese characteristics grew into an unsustainable business – fundamentally no different from debt-fuelled sub-prime mortgages, or CDOs cubed, in the West.
The big difference this time is its China! China has done things… differently. The path China pursued in its recovery and growth since 1980 has not been without… consequences.
Thus far we’ve praised China for its spectacular growth and the creation of valuable companies under the red banner of Chinese capitalism. It is going to be “interesting” to see how the subsequent mess is cleared out. Questions about Moral Hazard are going to be shockingly simple – Government has made it abundantly clear that any wrongdoing by company executives will be punished in the harshest possible way.
More importantly, Chinese politics and business works on a very different playing field to the west. Forget the rule of law or the T&C’s of Evergrande bonds. It easy to dismiss and characterise the way Chinese business works as institutionalised systemic corruption – but it’s a system Ancient Roman Emperors would recognise as a patron/client relationship. Emperor Xi’s clients and his princelings will continue to benefit from his patronage in return for their support at his court, and will be protected in a meltdown. The system Xi presides over will have little motivation to intervene to protect western investors who find themselves caught in the Evergrande fiasco.
Where Xi will have to take notice is outside the rich, wealthy princeling cadre which increasingly owns and runs China. There will be massive implications for wealth/inequality among the Chinese people from a property collapse. With a third of Chinese GDP dependent on the property sector, (and about 4 million jobs at Evergrande), the collapse of one of the biggest players, and the likelihood others will follow is much more than just a systemic risk.
Property is a key metric in the aspirations to wealth of the rising Chinese middle classes. The same smaller Chinese investors and savers will likely prove the largest losers from the property investment schemes they were sucked into. These real losses will rise if hidden bank exposures trigger a domestic banking crisis – which apparently isn’t likely (meaning it is..). There are reports of investor protests in key China cities – putting pressure on the govt to act to mitigate personal losses.
Xi’s clampdown on big tech is painted as the Party’s programme to engineer a more socially-equal economy. He has pinned the blame for rising inequality on “corrupt” business practices and has his cadre’s waving books on Xi thought, mouthing slogans about “common prosperity” and “frugality”. These are going to look increasingly hollow if the middle classes bear the coming Evergrande pain, and the Party Princelings continue to prosper.
The really big risk in China is not that Evergrande is going to default – it’s much bigger. If the Party is seen to fail in its promise to deliver wealth, jobs and prosperity for the masses – then that is very serious. China’s host of failed EV companies, an economy still reliant on exporting other nations tech, and a massively overvalued property sector (that the masses still equate with prosperity) all suggest a much less solid economy than the Party promotes.
If the illusion of a strong economy is unravelling – who knows what happens next, but in Ancient Rome the answer would be simple… Blame someone else, and invade..
This could get very “interesting…” and not in a good way.
Five Things To Read This Morning
Out of time, and back to the day job..
Strategist, Shard Capital