Commentary on Political Economy

Saturday 31 July 2021

ANOTHER DAY IN THE LIFE of a Franciscan monk

The “social logic” behind organising a lottery to induce individuals to vaccinate is the same logic that induces entire populations to seek certain collective ruin… for the chance of individual gain! It’s the “free rider” problem that afflicts “the commons” - what the sharp Cambridge economist theoretician Alec Pigou called “externality” (in his The Economics of Welfare). 

So, whilst it is true that Western individual investors have benefited from pouring money into China, the bigger and uglier truth is that we have collectively created a Frankenstein monster that now is… our “sum of all fears”.

And that is what Joseph Sternberg argues at the WSJ in the link below. (What I call “social logic”, Mancur Olson called “The Logic of Collective Action”. Or should that be “the illogic”?)

There are two important points here: unlike dictatorships, the West allows some of its citizens to sell rope to others so they can hang themselves (like selling razor blades to children). The second point Sternberg makes is more original: I have not seen it anywhere before. According to him, one of the reasons for the Xi Dictatorship to block Chinese companies from disclosing their accounts is that doing so would alert Western investors and governments to the dire situation of the Chinese financial system! … How interesting… 

The relevant passage is this:

“The Chinese government never allowed its economy to move in such a direction. The obvious reason is the party’s intention to retain control of the commanding heights of Chinese business. The subtler reason is that the transparency that would come with foreign ownership and control would reveal an awful lot of awkward truths about the state of China’s domestic economy. Hence also the controversy surrounding Beijing’s refusal to allow Chinese audit firms to turn over their records to American regulators in line with Washington’s rule for companies listed in the U.S. Presumably the government is shielding interactions between Chinese companies and state-owned banks, or dealings between the private economy and a corrupt party-state apparatus.”

It’s becoming noticeable that up until recently, when Treasury yields headed south, the US dollar went down as yields climbed, whereas now the greenback is soaring as… treasury yields sink… Obviously, until recently, money markets required high yields to buy dollars because they saw better opportunities elsewhere… But now, yields are falling, and bond prices climbing, carrying the dollar higher,… because people are scared stiff about… about what? Two possibilities: (a) lower growth or recession, or (b) a financial Armageddon… mmm…

The recession or stagnation hypothesis would rely on the virus or inflation, or both. The Armageddon hypothesis would rest on a leap in inflation (supply constraints, social conflict) and  central banks being forced to hike interest rates steeply and precipitously… with consequent implosion of the financial system (because of the term structure of loan contracts). Wherever you turn, there are zombies (insolvent enterprises) and nightmares aplenty!

The common saying is “don’t fight the Fed”. That may be valid when the Fed has room to manoeuvre… printing money in a recession. But not when the Fed is trying to suppress inflation… by raising interest rates! In that case, the Fed will either destroy the value of money or it will stifle the economy. The political ramifications would be horrendous either way given the absurd debt levels that monetary authorities have allowed…

Shapiro in the AFR, this morning, about China:

“But surprisingly, the view of some investors that fish in global markets, is that China is acting quite sensibly in sticking it to some of its globally listed champions. Chinese authorities are learning from the mistakes of the West when it comes to health, education and the social cost of monopolistic big tech.

“They have told the delivery companies like Meituan to pay minimum wage and treat the drivers fairly. There is nothing wrong with that,” says Garry Laurence of new global fund Profeta on the crackdown in that industry.

“If you didn’t mention which country you are talking about, then many of the moves would be seen as sensible and normal,” said Arian Neiron, the managing director of VanEck in Asia Pacific.

"Tightening up on the (mis)use of personal and potentially sensitive data, providing decent, affordable, quality education, providing occupational insurance for gig workers, preventing monopolistic behaviour and enhancing competition and opening up the financial system to wider foreign participation.”

Wednesday 28 July 2021


Chinese Property Titan Teeters as Investor Confidence Fades

China Evergrande Group’s debt-fueled growth powered its ascent, before problems started to mount 

A residential project developed by China Evergrande Group in Hong Kong, pictured last week.

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HONG KONG—For years, China Evergrande Group EGRNF -16.67%rode some of the biggest trends in Chinese finance, using debt-fueled growth to capitalize on a seemingly unstoppable property boom in China.

Global investors, many of whom believed the developer was too big to fail, bought up its high-yielding U.S. dollar bonds to earn fat returns.

Now, Chinese entrepreneur Hui Ka Yan’s real-estate-focused conglomerate is struggling to adapt to a new era—and its depressed stock and bond prices point to shaken investor confidence.

Higher YieldingYield on Evergrande bond due 2025*Source: TradewebNote: Shows $4.68 billion, 8.75% bond due June 2025.
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Four-year bonds that Evergrande sold in January 2020 with a 12% coupon were recently bid at about 53 cents on the dollar, according to Tradeweb, reflecting investors’ pessimism about being made whole when the debt comes due. On Monday, S&P Global Ratings downgraded Evergrande two notches to B-, citing a “severe decline in profitability” as the company cut prices of its apartments to boost sales.

Evergrande’s stock tumbled 13% on Tuesday after the company scrapped plans for a special dividend, and has declined 61% in the year to date, according to FactSet.

The property developer, which was founded in 1996, is Asia’s second-largest issuer of U.S. dollar junk bonds after Japan’s SoftBank GroupCorp. , according to Refinitiv. Evergrande-related companies have sold $25.4 billion in such bonds, according to a Refinitiv tally of all such debt ever sold by these companies. Some of these bonds have already been repaid. Evergrande is on the hook to repay $19.5 billion of them between 2022 and 2025, according to FactSet.

Evergrande in late June said it had the equivalent of $88 billion in interest-bearing debt of all kinds, which includes domestic borrowings from banks and other lenders.

Several recent episodes have rattled markets. Earlier this month, a court in the eastern province of Jiangsu agreed to freeze some Evergrande assets. The company subsequently said its dispute with a bank there was resolved. Separately, a local government in central China’s Hunan province briefly prevented the company from preselling unfinished apartments.

Back to EarthEvergrande's Hong Kong sharesSource: FactSetNote: HK$1 = $0.1287

The changing stance of Chinese authorities is a big part of Evergrande’s problems. Officials have grown wary of overheating property markets, pushing weaker developers to cut debts, and banks to scale back real-estate lending. In recent days, a group of regulators also outlined new policies to control the property market.

At the same time, Chinese authorities in recent years have become more tolerant of corporate defaults.

“Evergrande’s weak liquidity position is the reason why we’ve seen so much volatility. Investors are starting to doubt whether the company can repay its upcoming obligations or not,” said Luther Chai, a senior analyst with CreditSights in Singapore.

Evergrande reported 6.2% growth in revenue last year, to the equivalent of $78 billion, but net income fell by more than half, to the equivalent of about $1.25 billion.

The company ended 2020 with about $24.5 billion of cash and equivalents, and some $51.8 billion of borrowings due within a year, according to its annual report.

Chinese entrepreneur Hui Ka Yan’s Evergrande has seen its share price tumble this year.


Evergrande says it is moving rapidly to get on the right side of the regulators’ leverage requirements, known as the “three red lines,” and is executing a plan to curb debt, boost sales and keep its overall scale under control. It is also diversifying into fields such as electric cars, where it can raise cash by selling stakes in subsidiaries.

In June, Evergrande stressed it has never missed an interest or principal payment since its founding. After repaying some maturing debt in June, it has no more bonds due this year. The company didn’t respond to requests for further comment.

Other aspects of Evergrande’s finances concern some analysts, such as Nigel Stevenson of GMT Research, a longtime skeptic on the stock. He pointed to its tendency to pay big dividends rather than conserve cash, and what he called problematic balance-sheet assets.

Evergrande had some $355 billion of assets as of end-2020, largely property under development, held for sale, or classed as investment.

Some smaller property groups have defaulted recently, includingChina Fortune Land Development Co. and Sichuan Languang Development Co. If Evergrande were to run into financial difficulties, that could affect bondholders, suppliers, bank lenders and customers who have bought as-yet unfinished apartments.

To be sure, Evergrande could find a way out of trouble, as it has done repeatedly before. “Many people have faith in Evergrande, because it has come back to life after countless crises,” said Li Gen, chief executive officer of Beijing BG Capital Management Ltd.

Supply and DemandHengda, Evergrande's key onshore unit, reliesincreasingly on commercial bills for funding.Commercial bills outstanding at year-endSource: Hengda Real Estate Group Co. bond filings.
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Mr. Li pointed to the company’s record of finding new ways to raise funds, and previous instances of state support, for example when two local-government-backed businesses last year agreed to take over stakes in Evergrande’s main onshore subsidiary, Hengda Real Estate Group Co.

Investors have grown nervous even as Evergrande has quickly trimmed its headline debt levels. Late June’s $88 billion debt figure represented a drop of nearly one-third in a year. It also said its net debt-equity ratio was less than 1, bringing it in line with one of the three red lines. The other two compare cash to short-term debt, and liabilities against assets. Evergrande hasn’t yet reached the required levels for these metrics.

However, analysts say that Evergrande and its peers have found other ways to fund themselves—in effect borrowing from suppliers, customers or business partners.

Evergrande’s Hengda unit has issued growing amounts of commercial bills to suppliers, which don’t count toward headline debt figures. It had the equivalent of $31.7 billion of bills outstanding as of end-2020, filings show.

Big Chinese developers have turned to funding sources like customer deposits and financing from non-controlling shareholders, said Andrew Lawrence, a property analyst at TS Lombard.

“Our analysis of major developers’ 2020 financial statements showed that, overall, they had lowered their debt to equity, but their total liabilities to equity—a better measure of leverage—remained high,” he said.