The Economics Forum 21: A FRANCISCAN FRIAR FOR ALL SEASONS

Excellent summary of the financial debt pyramid and growing non-performaning loans (NPL) from Carmen Reinhardt:

The Quiet Financial Crisis

Jan 7, 2021

CARMEN M. REINHART

The global COVID-19 pandemic has resulted in soaring infection rates, widespread lockdowns, record-shattering declines in output, and spiking poverty. But, in addition to these trends, a quieter crisis now gaining momentum could jeopardize economic recovery prospects for years to come.

WASHINGTON, DC – The term “financial crisis” has long been associated with dramas such as bank runs and asset-price crashes. Charles Kindleberger’s classic books The World in Depression, 1929-1939 and Manias, Panics and Crashes, and my own work with Kenneth Rogoff, This Time Is Different, document scores of these episodes. In recent years, the term “Lehman moment” has stood out as a marker of the 2007-09 global financial crisis and even inspired a Broadway show.

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But some financial crises do not involve the drama of Lehman moments. Asset quality can deteriorate significantly as economic downturns persist, especially when firms and households are highly leveraged. Moreover, years of bank lending to unproductive private firms or state-owned enterprises (the latter is not uncommon in some developing countries) take a cumulative toll on balance sheets.

Although these crises may not always include panics and runs, they still impose multiple costs. Bank restructuring and recapitalization to restore solvency can be expensive for governments and taxpayers, and new lending can remain depressed, slowing economic activity. The credit crunch also has distributional effects, because it hits small and medium-size businesses and lower-income households more acutely.

To be sure, the COVID-19 pandemic continues to deliver many moments of unwanted drama, including soaring infection rates, widespread lockdowns, record-shattering declines in output, and spiking poverty. But, in addition to these trends, a quieter crisis is gaining momentum in the financial sector. Even without a Lehman moment, it could jeopardize prospects for economic recovery for years to come.

Specifically, financial institutions around the world will continue to face a marked rise in non-performing loans (NPLs) for some time. The COVID-19 crisis is also regressive, disproportionately hitting low-income households and smaller firms that have fewer assets to buffer them against insolvency.1

Since the onset of the pandemic, governments have relied on expansionary monetary and fiscal policies to offset the steep declines in economic activity associated with broad-based shutdowns and social-distancing measures. Wealthier countries have had a decided advantage in their ability to respond, although a surge in lending by multilateral institutions has also helped to finance emerging and developing economies’ response to the health emergency.

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Unlike in the 2007-09 crisis (or most previous crises, for that matter), banks have supported macroeconomic stimulus with a variety of temporary loan moratoria, as the International Monetary Fund has documented in its Policy Tracker. These measures have provided some respite for households facing loss of employment and a decline in income, as well as for businesses struggling to survive lockdowns and general disruptions to normal activity (tourism-linked sectors stand out starkly in this regard).

Financial institutions in all regions have granted grace periods for repayment of existing loans, and many have re-contracted loans in favor of lower interest rates and generally better terms. The understandable rationale has been that, because the health crisis is temporary, so is the financial distress of firms and households. But as the pandemic has persisted, many countries have found it necessary to extend these measures until 2021.

Alongside the temporary moratoria, many countries have relaxed their banking regulations regarding bad-loan provisioning and the classification of loans as non-performing. The upshot of these changes is that the extent of NPLs may currently be understated, and for many countries markedly so. In many cases, financial institutions may be insufficiently prepared to deal with the hit to their balance sheet. The less regulated non-bank financial sector, meanwhile, has even greater exposure to risk (compounded by weaker disclosure).

Adding to these private-sector developments, downgrades of sovereign credit ratings reached a record high in 2020 (see figure below). Although advanced economies have not been spared, the consequences for banks are more acute in emerging and developing economies where governments’ credit ratings are at or near junk grade. In more extreme cases of sovereign default or restructuring – and such crises are on the rise, too – banks will also take losses on their holdings of government securities.

As I argued in March 2020, even if one or more effective vaccines promptly resolve the pandemic, the COVID-19 crisis has significantly damaged the global economy and financial institutions’ balance sheets. Forbearance policies have provided a valuable stimulus tool beyond the conventional scope of fiscal and monetary policy. But grace periods will come to an end in 2021.

As the US Federal Reserve’s November 2020 Financial Stability Report highlights, policy fatigue or political constraints suggest that forthcoming US fiscal and monetary stimulus will not match the scale reached in early 2020. Many emerging markets and developing countries are already at or near their monetary-policy limits as well. As 2021 unfolds, therefore, it will become clearer whether countless firms and households are facing insolvency rather than illiquidity.

Firms’ high leverage on the eve of the pandemic will amplify the financial sector’s balance-sheet problems. Corporations in the world’s two largest economies, the United States and China, are highly indebted and include many high-risk borrowers. The European Central Bank has repeatedly voiced concerns about the rising share of NPLs in the eurozone, while the IMF has frequently warned about the marked increase in dollar-denominated corporate debt in many emerging markets. Exposure to commercial real estate and the hospitality industry is another source of concern in many parts of the world.

Balance-sheet damage takes time to repair. Previous overborrowing often results in a long period of deleveraging, as financial institutions become more cautious in their lending practices. This muddling-through stage, usually associated with a sluggish recovery, can span years. In some cases, these financial crises develop into sovereign-debt crises, as bailouts transform pre-crisis private debt into public-sector liabilities.

The first step toward dealing with financial fragility is to recognize the scope and scale of the problem, and then expediently restructure and write down bad debts. The alternative – channeling resources into zombie loans – is a recipe for delayed recovery. Given the pandemic’s already huge economic and human costs, avoiding that scenario must be a top priority for policymakers everywhere.

Barron’s on Evergrande:

“The group also has a large network of loans. Monday was a deadline for domestic bank loan repayments, with a 24-hour grace period; in a note, Deutsche Bank strategistssaid there was a 24-hour grace period from the Monday deadline. Chinese authorities warned banks last week that Evergrande wouldn’t meet these obligations.

A bigger pinch is likely to come Thursday when coupon payments for both domestic and offshore bonds are due. BlackRock (BLK), UBS (UBS) and HSBC (HSBC) are among the company’s bondholders.

Macro strategists at UBS, led by Kamil Amin, now view a significant credit default as unavoidable.

Why Are Investors Worried?

If Evergrande ultimately fails, it would be a major sign of trouble for China’s indebted property sector and could be the first of a wave of bankruptcies.

The cash crunch at Evergrande coincides with a general slowdown in China’s property market, exacerbated by higher mortgage rates and stricter rules for borrowers. Regulators have been cracking down on what they see as an overheated property market, with rules introduced last year to limit borrowing in the real estate sector.

If Evergrande can’t pay its debts, then the company’s lenders—including some of China’s largest banks—will come under pressure. That, in turn, could make it difficult for companies that need to borrow money from banks and bond markets to access funds.

If this happens, it would mark the makings of a financial crisis in the world’s second-largest economy, and could cause wider instability internationally.”

I find it exquisitely gratifying…that BLACKROCK are among the biggest bond holders, as well as the rats at HSBC who should all burn in hell with their masters in Beijing… Just last week, Blackrock were raising billions from Western suckers to invest in Ratland, against George Soros’s pointed warning, followed today by El-Erian questioning whether China is “investable” (it should be “investible”, but English speakers are not versed in Latin).

“As Al Root of Barron’s wrote, credit default swaps (CDS), where one party swaps the risk of debt default with another party, is beginning to show signs of building panic in the wider debt market. HSBC’s five-year CDS were up 16% Monday—a lot, but not at levels indicating all-out panic.”

This is what Feudalism looks like:

Evergrande Gave Workers a Choice: Lend Us Cash or Lose Your Bonus

The Chinese property giant owes $300 billion and is on the hook for as many as 1.6 million apartments. It may owe tens of thousands of its employees money, too.

At Evergrande’s headquarters in Shenzhen, China, on Wednesday. Employees who say the company pressured them for cash have joined angry home buyers in demanding their money back.

At Evergrande’s headquarters in Shenzhen, China, on Wednesday. Employees who say the company pressured them for cash have joined angry home buyers in demanding their money back. Credit... Noel Celis/Agence France-Presse — Getty Images

Published Sept. 19, 2021

Updated Sept. 20, 2021, 2:59 p.m. ET

When the troubled Chinese property giant Evergrande was starved for cash earlier this year, it turned to its own employees with a strong-arm pitch: Those who wanted to keep their bonuses would have to give Evergrande a short-term loan.

Some workers tapped their friends and family for money to lend to the company. Others borrowed from the bank. Then, this month, Evergrande suddenly stopped paying back the loans, which had been packaged as high-interest investments.

Now, hundreds of employees have joined panicked home buyers in demanding their money back from Evergrande, gathering outside the company’s offices across China to protest last week.

Once China’s most prolific property developer, Evergrande has become the country’s most indebted company. It owes money to lenders, suppliers and foreign investors. It owes unfinished apartments to home buyers and has racked up more than $300 billion in unpaid bills. Evergrande faces lawsuits from creditors and has seen its shares lose more than 80 percent of their value this year.

Regulators fear that the collapse of a company Evergrande’s size would send tremors through the entire Chinese financial system. Yet so far, Beijing has not stepped in with a bailout, having promised to teach debt-saddled corporate giants a lesson.

The angry protests led by home buyers — and now the company’s own employees — may change that calculus.

Evergrande is on the hook to buyers for nearly 1.6 million apartments, according to one estimate, and it may owe money to tens of thousands of its workers. As Beijing remains relatively quiet about the company’s future, those who are owed cash say they are growing impatient.

“There isn’t much time left for us,” said Jin Cheng, a 28-year-old employee in the eastern city of Hefei who said he put $62,000 of his own money into Evergrande Wealth, the company’s investment arm, at the request of senior management.

As rumors rippled through the Chinese internet that Evergrande might go bankrupt this month, Mr. Jin and some of his colleagues gathered in front of provincial government offices to pressure the authorities to step in.

In the southern city of Shenzhen, home buyers and employees crowded into the lobby of Evergrande’s headquarters last week and shouted for their money back. “Evergrande, give back my money I earned with blood and sweat!” some could be heard yelling in video footage.

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Mr. Jin said employees at Fangchebao, Evergrande’s online platform for real estate and automobile sales, were told that each department had to put monthly investments into Evergrande Wealth.

A woman sobbed outside the company’s Shenzhen headquarters. Protests have taken place at Evergrande offices across China.

Evergrande did not respond to a request for comment, but the company recently warned that it was under “tremendous” financial pressure and said it had hired restructuring experts to help determine its future.

Things were not always this way.

For more than two decades, Evergrande was China’s largest developer, minting money from a property boom on a scale the world had never seen. With each success, Evergrande expanded into new areas — bottled water, professional sports, electric vehicles.

Banks and investors happily threw in money, making a bet on China’s growing middle class and its appetite for homes and other properties. More recently, real estate has come under scrutiny from Chinese regulators who want to end the go-go years of the boom and have forced the industry to start paying off debt.

Business & Economy

Sept. 20, 2021, 2:17 p.m. ET

3 hours ago

The idea was to reduce Chinese banks’ exposure to the property sector. But in the process, the regulators took away the money that developers like Evergrande needed to finish building houses, leaving families without the homes for which they had already paid.

“The Chinese financial system is really complex and when you see fissures like this you realize the impact it could possibly have on society,” said Jennifer James, an investment manager at Janus Henderson Investors. “If Evergrande were to disappear tomorrow, it could be a socially systemic issue.”

Ms. James and other investors said they learned about Evergrande’s wealth management strategy involving its employees only this month, when the company disclosed that it owed $145 million in repayments.

Evergrande has tried to sell off parts of its vast empire to raise new funds, but said last week it was “uncertain as to whether the group will be able to consummate any such sale.” It accused the news media of triggering a panic among home buyers with negative coverage.

But Evergrande’s funding channels started drying up well before last week. According to interviews with employees, state media reports and corporate documents seen by The New York Times, the company started forcing staff members to help bail it out as early as April, when it began peddling the short-term loans.

Around 70 to 80 percent of Evergrande employees across China were asked to put up money that would then be used to help fund Evergrande operations, Liu Yunting, a consultant for Evergrande Wealth, recently told Anhui Online Broadcasting Corporation, a state-owned news group.

A version of that interview was taken offline on Friday. Anhui Online Broadcasting did not respond to a request for comment.

The extent of the campaign and how much money it might have raised were unclear. Employees were told to each invest a certain amount of money in Evergrande Wealth products, and that if they failed to do so, their performance pay and bonuses would be docked, employees told Anhui.

Company management said the investments were part of “supply chain financing” and would allow Evergrande to make payments to its suppliers, Mr. Liu said in his interview with Anhui. “Because we employees had to complete a quota, we asked our friends and families to put money in,” he said.

Mr. Liu said his parents and in-laws had invested $200,000, and that he had put about $75,000 of his own money into Evergrande Wealth.

Even before the protests last week, Evergrande was on Beijing’s bad side. Late last month, its executives were summoned to a meeting with regulators. Officials from China’s top banking and insurance watchdogs told executives to sort out their towering debt in order to maintain the stability of China’s financial market.

The biggest concern for the authorities is Evergrande’s unfinished apartments. The company has nearly 800 developments in progress in more than 200 cities across China.

Evergrande, which often presold apartments to raise cash before they were completed, may still to need to deliver as many as 1.6 million properties to home buyers, according to an estimate from Barclays.

Under heightened scrutiny, Evergrande gathered its top executives earlier this month and asked them to publicly sign what it called a “military order” — a pledge to complete unfinished property developments.

Wesley Zhang and his family are among the hundreds of thousands of families who are still waiting for their apartments, and they hope the company will be able to deliver. Mr. Zhang, 33, joined the other home buyers who protested in Hefei last week after he learned that Evergrande also owed money to its employees.

“Everyone is anxious, we are a bit like ants on a hot pan, having no idea what to do,” Mr. Zhang said, using a Chinese expression to describe the distress of watching a $124,000 investment potentially vanish. He said he hoped the protests would prompt the government to act before it was too late.

From Bloomberg:

Too Big to Fail: China Edition

On a Financial Nightmare scale that runs from “New Jersey deli is worth $100 million” to “Lehman Brothers,” China Evergrande Group probably falls somewhere in the middle, maybe just below “Long-Term Capital Management.” It could be terrible. It probably won’t be. Hopefully.

Global markets didn’t wait to have a big old freak-out about the idea of Evergrande Fever spreading around the world. U.S. stocks suffered their biggest puke in almost a year. But it’s hard to see how this Chinese developer — which is massive but only about half as indebted as Lehman was — would trigger another global financial crisis, especially when China has no desire whatsoever to chance anything like that happening, as John Authers writes.

Beijing does seem eager to end the frenzied borrowing that got Evergrande in trouble. And it doesn’t hesitate to attack companies that cloud the Communist Party’s vision for the economy; the next target could be Hong Kong property barons, writes Shuli Ren. But China would probably rather smother its big, scary debt problem with cash than let the economy burn right now.

Anyway, Evergrande has been slowly unraveling for weeks now. A more realistic explanation for today’s sudden market agita is that asset prices had gotten way ahead of themselves, ignoring toxic U.S. politics, the delta variant, a tightening Fed, AOC’s Met Gala dress and other horrors. All that blissful calm was terrible for trading revenue at America’s banks, writes Brian Chappatta. The same firms caught in the Lehman meltdown 13 years ago could use a nice, contained little market panic now.

Bonus Market-Panic-Fodder Reading:

The Fed should start tapering QE now, but it probably won’t. — Mohamed El-Erian

The Fed’s inflation-fighting credibility is at stake. — Bill Dudley

A Better Covid Response Is Possible

In excellent news for that large section of America’s Venn diagram where people who believe in vaccines overlap with people who have young children, Pfizer and BioNTech said their Covid shots worked safely in kids ages 5 to 11. The day is coming soon when we can send them to school even more safely.

Fortunately, for now, even the more contagious delta variant isn’t putting large numbers of young kids in the hospital or worse, writes Justin Fox. It has also been less deadly for the oldest Americans, probably because so many are vaccinated. But Covid is taking a tragic toll on young and middle-aged adults, who are of prime working age and also prime not-getting-vaccinated age, apparently:

This is all the more reason for companies to answer President Joe Biden’s invitation and impose a vaccine mandate on their workers, writes Tim O’Brien. It’s the best way to protect these vulnerable people and get us all out of the pandemic more quickly. And companies shouldn’t wait for OSHA to tell them what to do.

Bonus Pandemic-Impact Reading: WFH is an overrated trend, says economist Enrico Moretti. Big cities will stay big. — Justin Fox

Facebook Has a Toxic Golden Goose Problem

Facebook has a dilemma, writes Parmy Olson: On the one hand, everybody is angry with it for pumping toxic garbage into people’s heads all day long, shredding democracy and the very fabric of our society. On the other hand, toxic garbage is good for business. Facebook’s team in charge of “growth” — a word that can mean either “expansion” or “a kind of tumor” — has Mark Zuckerberg’s ear, and its primary mission is keeping people glued to Facebook as much as possible. And people love snarfing brain poison all day long, it turns out. Something has to give here, unless Facebook just wants even more regulatory scrutiny.

Bonus Tech-Oligarch Reading: While Elon Musk wins the space race, Jeff Bezos slows it down with lawsuits complaining about his losses. — Adam Minter

Telltale Charts

Europe is running low on gas supplies ahead of winter, with little relief in sight, writes Julian Lee. There will soon be an oversupply of populist outrage about rising energy costs, writes Lionel Laurent.

Everybody remembers Germany’s hyperinflation wrong, including the Germans, writes Andreas Kluth. In the popular imagination, the Weimar Republic’s hyperinflation led directly to the Nazis taking power. For some reason we all forget that Germany’s real problem in the 1930s — the time of the Great Depression, you may recall — was not hyperinflation but deflation.

BlackRock and HSBC funds boosted Evergrande holdings as crisis loomed

Investors added to bond holdings in Chinese property developer while prices began sliding

Apartment buildings and recreational facilities at China Evergrande Group’s Life in Venice real estate and tourism development in Qidong

An Evergrande development in Qidong, near Shanghai: The bonds of the world’s most indebted property developer have for weeks traded at highly distressed levels © Bloomberg

September 21, 2021 1:52 pm by Thomas Hale and Tabby Kinder in Hong Kong and Stephen Morris in London

Funds managed by BlackRock and HSBC added to their holdings of Evergrande bonds just months before a liquidity crisis at the Chinese property developer pushed it to the brink of default.

BlackRock in August bought up five different Evergrande dollar bonds through one of its high-yield funds, which had holdings in the developer then worth $18m, Morningstar data show. The size of the holding had already expanded sharply this year as the fund’s assets under management rose.

The world’s biggest asset manager had total exposure of close to $400m across its funds, according to data compiled by Bloomberg based on June, July and September filing dates.

A HSBC-run high yield fund in July was also a net buyer of Evergrande’s debt and has increased bond holdings by 38 per cent since February as the fund expanded in size, the Morningstar data showed, though the value of its total exposure at $31m declined over that period due to falling prices.

Line chart of Cents on the US dollar showing Evergrande bond prices tumble

The data highlight a willingness on the part of some of the biggest investors in Evergrande’s offshore bonds to continue to add to their holdings even after prices had started falling in the earlier stages of a liquidity crisis that is now rippling across international markets.

Numerous investors are likely to have at least some exposure to Evergrande, as its bonds are a large component of indices that track dollar-denominated Asian company debt. The group’s debt traded on offshore markets accounts for only a small proportion of its wider $300bn in obligations to creditors and businesses, meaning the exposure these asset managers have more broadly remains limited.

BlackRock declined to comment on its investment in Evergrande’s debt. HSBC’s asset management unit said, “as with many sectors we invest in, we closely monitor developments in the real estate sector”.

The bonds of the world’s most indebted property developer have for weeks traded at highly distressed levels as it seeks to stave off a default on interest payments it owes on Thursday on its offshore bonds. A dollar-denominated bond maturing next year is trading at below 30 cents on the dollar, compared to close to its face value in late May.

S&P Global Ratings expects the company to default this week and estimates it has close to $20bn in dollar-denominated bonds outstanding from two offshore subsidiaries.

Ashmore, the emerging market investment specialist, had the highest exposure with more than $400m of its bonds as of the end of June, Bloomberg-compiled data showed, while UBS had close to $300m of exposure to Evergrande bonds as of the end of April, May, June and July. UBS and Ashmore declined to comment.

In a note to clients last week, UBS said: “We continue to hold Evergrande in fixed maturity funds because exiting the position at this point removes any optionality around a successful resumption in construction activity, external financial assistance, or policy adjustment in the coming months, and Evergrande bonds are now trading at or below typical historical recovery values”.

Recommended

Evergrande used retail financial investments to plug funding gaps

Evergrande is the best-known international borrower across China’s real estate developers, a highly-leveraged sector that has relied heavily on Asian dollar bond markets over the past decade but is now under pressure from Beijing to reduce its debts.

Earlier this summer investors ramped up their bets against Evergrande bonds as prices began to tumble on waves of bad news, including frozen deposits and the halting of projects by local authorities, followed by angry retail investors descending on its Shenzhen headquarters last week.

The company has long attracted market scrutiny for its debt load, which is the largest of any property developer in the world.

“I have forbidden anyone [that works for me] from touching Evergrande equity or debt for 20 years,” said the chief executive of a private equity fund in Hong Kong. “It has always been obvious that it is super high risk and one day it would all end suddenly in tears”.

TERRIFIC piece by TERRY (McCrann):

China’s fake numbers hide a bigger mysteryTERRY MCCRANN

The halted under-construction Evergrande Cultural Tourism City, a mixed-used residential-retail-entertainment development, in Taicang, Suzhou city, in China's eastern Jiangsu province. (Photo by Vivian LIN / AFP)

5:56PM SEPTEMBER 21, 202110

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There’s a bigger and far more important point about the utter unbelievability of Chinese statistics, projected most graphically in the obvious fantasy of their minuscule Covid numbers, than simply that they lie statistically for some purpose.

Put aside my comparison of the Australia and China Covid numbers; do you really think that China has had fewer Covid cases than Cyprus, population just over one million?

Or that China has had barely half the Covid cases of Norway, population 5 million?

This bigger point is the impossibility of really knowing what is going on, much more broadly and granularly, inside China, beyond the glitzy images of very fast train networks, those spectacular freeways, all those high-rise cities and seemingly pervasive conspicuous consumption.

A child undergoes a test for the Covid-19 coronavirus in Xiamen, in China's eastern Fujian province on September 18, 2021. (Photo by STR / AFP) / China OUT

That, in a sense, trying to bring it all together in a simple digestible projection, we should see Shanghai as just a more northern version of Hong Kong or Singapore.

The tragic part is, of course, that Hong Kong is well on the way to becoming – to being brutally forced to becoming - a southern version of Shanghai . But that’s outside the scope of my comment today.

READ MORE:Westpac manager gambled at Crown with stolen millions|Retail bracing for ‘revenge spending’ as restrictions ease|Sky News’ Wuhan doco draws huge interest

So-called experts who claim to “know about China” are the 21st century versions of the dupes – journalists and academics and celebrities – who told us in the 1920s and the 1930s that the Soviet Union was a workers paradise, just when it was killing millions of them and half-starving tens of millions.

No, I’m not suggesting that all that sort of thing is being replayed in China now. The lack of knowledge goes to really knowing what drives decisions and events and the interplay between different power centres, on complex levels where bureaucracy, the party and business intersect.

A big part of the delusion of seeming understanding comes from the pervasive interfaces we now have across China with both operational businesses – all that ‘stuff’ made there, and the raw materials bought to make it, most prominently in our case of course, iron ore –and the financial sector.

So we get an Evergrande, one of China’s biggest property developers, that was created by the force-fed building of China’s ‘ghost cities, and is now utterly insolvent in conventional western terms.

Is it China’s Lehman – the collapse that triggered the GFC?

It’s impossible to know; just as it’s impossible to know why it’s really happening, and indeed as yet if it actually will happen.

Just as it is impossible to know why exactly Chairman Xi seemingly cracked down on the – some of the? – billionaires; most prominently Alibaba’s Jack Ma, who is now ‘back’ after apparently paying a ‘fine’ running into the billions.

The same advice applies to ‘events’ like Evergrande as it does to ‘statistics’ – whether for Covid or GDP. Don’t believe the number, trust only the reality.

If China’s buying less iron ore from us and the price plunges; don’t try to ‘know’ why – the belief that you can get to ‘the answer’ is and always is a delusion - just deal with the reality.

Maybe Evergrande and its supposed $400bn of debts - but who really knows what financial obligation linkages there really are – does formally collapse. Like one of its buildings.

In both cases the only rational course would be to deal with the rubble.

As I wrote earlier in the month, the sudden plunge in the iron ore price was tracking eerily similar to the two previous times that it had rocketed to dizzyingly high levels, both times because of China, in 2008 and 2012.

In both previous cases, it plunged and it plunged suddenly and significantly. Is this plunge from $US230 to $US95, so far, significant enough? I don’t know and believing you can know is a delusion – even before you get to the broader questions about the “China miracle”.

TERRY MCCRANNBUSINESS COMMENTATOR

ESSENTIAL READING

Chinese economy

Evergrande and the end of China’s ‘build, build, build’ model

Valued at $320bn in 2020, the spectacular unravelling of the property group exposes deep flaws in Beijing’s growth strategy

September 22, 2021 2:13 am by James Kynge in Hong Kong and Sun Yu in Beijing

A dramatic video filmed in the southwestern city of Kunming in August hints at the scale of China’s property bubble. Onlookers can be heard screaming in awe as 15 high-rise apartment blocks are demolished by 85,000 controlled explosions in less than a minute.

The unfinished buildings, which formed a complex called Sunshine City II, had stood empty since 2013 after one developer ran out of money and another found defects in the construction work. “This urban scar that stood for nearly 10 years has at last taken a key step toward restoration,” said an article in the official Kunming Daily after the demolition.

Such “urban scars” are common all over China, where Evergrande — the world’s most heavily indebted property company — is suffering a liquidity crunch that could prove terminal. The crisis at the company, which as recently as two years ago ranked as the world’s most valuable property stock, highlights both the speed at which corporate fortunes can unravel and the deep flaws in China’s growth model.

Evergrande, for all of the high drama of its meltdown, is merely the symptom of a much bigger problem. China’s vast real estate sector, which contributes 29 per cent of the country’s gross domestic product, is so overbuilt that it threatens to relinquish its longstanding role as a prime driver of Chinese economic growth and, instead, become a drag on it.

A worker carrying buckets at the construction site of the Raffles City Chongqing in southwest China’s Chongqing municipality

A worker carrying buckets at the construction site of the Raffles City Chongqing in south-west China’s Chongqing municipality © Wang Zhao/AFP/Getty Images

There is enough empty property in China to house over 90m people, says Logan Wright, a Hong Kong-based director at Rhodium Group, a consultancy. To put that into perspective: there are 5 G7 countries — France, Germany, Italy, the UK and Canada — who could fit their entire populations into those empty Chinese apartments with room to spare.

“We estimate existing but unsold housing inventory is in the range of 3bn square metres, which is enough to house 30m families, conservatively,” Wright says, explaining his calculations. The average size of a household in China is just over three people, giving enough space for over 90m people.

Oversupply has been a problem for several years. What changed is that last year China decided the issue had become so chronic that it needed to firmly address it. President Xi Jinping had also run out of patience with the excesses of the property sector, say observers, and Beijing formulated “three red lines” to reduce debt levels in the sector. Evergrande is proving to be the first big victim.

Big Read: The liquidity squeeze on listed developers

As the company falters, its undoing raises a fundamental question for the world’s second-largest economy: has China’s property-driven growth model — the global economy’s most powerful locomotive — run out of road?

Yes, says Leland Miller, chief executive of China Beige Book, a consultancy which analyses the economy through proprietary data. “The leadership in Beijing has been more worried about Chinese growth than anyone in the west.

“There is a recognition that the old build, build, build playbook does not work any more and that it is actually getting dangerous. The leadership now appears to be thinking that it can’t wait any longer to change the growth model,” Miller says.

Ting Lu, chief China economist at investment bank Nomura, says he does not expect Evergrande’s woes to trigger an economic collapse. But he believes Beijing’s attempts to transition from one growth model to another could significantly depress annual growth in coming years.

A housing complex developed by Evergrande sits unfinished in Luoyang

A housing complex developed by Evergrande sits unfinished in Luoyang © Carlos Garcia Rawlins/Reuters

“There is unlikely to be a sudden stop,” Lu says. “But I think China’s potential [annual] growth rate will drop to 4 per cent or even lower between 2025 and 2030.”

Wright says the property sector is becoming a threat to financial, economic and social stability — it has already sparked protests in several cities. “It is very difficult to provide a compelling narrative that China’s potential growth will exceed 4 per cent in the next decade,” Wright adds.

Miller echoes that sentiment. “We are set for a roller-coaster ride in policy and in economic growth,” he says “I would not be surprised if a decade from now GDP growth was 1 or 2 per cent.”

If such projections prove correct, the Chinese growth “miracle” is in peril. In the decade from 2000 to 2009, China’s GDP growth averaged 10.4 per cent a year. This stellar performance abated during the decade from 2010 to 2019, but annual GDP still grew by an average of 7.68 per cent.

Big Read: Measuring the debt load of China's local government financing vehicles

Any fall in growth would be swiftly felt worldwide. China has long been the biggest engine of global prosperity, contributing 28 per cent of GDP worldwide from 2013 to 2018 — more than twice the share of the US — according to a study by the IMF.

“Even if China avoids a sharp and sudden crisis,” says Jonas Goltermann at Capital Economics, a research firm, “its medium-term prospects are much worse than generally acknowledged.”

Crossing Xi’s ‘red lines’

The risks that spring from the Evergrande saga encompass both financial contagion — especially in the offshore US dollar bond market — and the prospect that a flagging property sector will strike at some of the vital organs of the Chinese economy, potentially depressing GDP growth for years to come.

The fallout from the crisis is already considerable. Evergrande’s plummeting share price has slashed the company’s market capitalisation from $320bn last year to about $3.7bn now. And concerns around its possible collapse triggered a global markets sell-off this week. Some 80,000 people in China who hold about $40bn in the company’s wealth management products are waiting nervously to see whether Evergrande will honour payment obligations. Offshore bondholders are bracing for a default, perhaps as early as Thursday, with one bond due to pay interest trading at about 30 per cent of its face value.

Xi Jinping at the Chinese Communist Party’s Congress in October 2017, where the president said ‘houses are for living in, not for speculation’

Xi Jinping at the Chinese Communist party’s Congress in October 2017, where the president said ‘houses are for living in, not for speculation’ © Wang Zhao/AFP/Getty Images

But potentially longer lasting impacts derive from the broader fall in China’s property market. It is clear that the real estate sector is in a tailspin, with sales in 52 large cities down 16 per cent in the first half of September year on year, extending a 20 per cent decline in August, according to official data.

An even more consequential trend for China’s political economy is the collapse in land sales by local governments, which fell 90 per cent year on year in the first 12 days of September, official figures show. Such land sales generate about one-third of local government revenues, which in turn are used to help pay the principal and interest on some $8.4tn in debt issued by several thousand local government financing vehicles. LGFVs act as an often unseen dynamo for the broader economy; they raise capital through bond issuance that is then used to fund vast infrastructure projects.

“We expect land sales revenue to get much worse,” says Nomura’s Lu.

This dwindling ability of local governments to raise finance to spend on infrastructure has the potential to depress Chinese growth considerably. Fixed asset investment, which last year totalled Rmb51.9tn ($8tn), constitutes 43 per cent of GDP.

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BlackRock and HSBC funds boosted Evergrande holdings as crisis loomed

Distress is already evident in an offshore US dollar bond market, where some $221bn in debt raised by several hundred Chinese property developers is trading. Big chunks of the market are currently priced for default. “A full 16 per cent of the market is trading at yields of over 30 per cent and 11 per cent of the market is trading at yields of over 50 per cent,” Wright says.

Yields of over 50 per cent suggest defaults are likely, he adds.

Ultimately, the fate of such bonds, and almost all other offshoots from the malaise in Chinese property, depends on Beijing. The Chinese state owns almost all of the country’s large financial institutions, meaning that if Beijing orders them to bail out Evergrande or other distressed property companies, they will follow orders.

In some overseas markets the idea that Evergrande’s distress may presage a “Lehman moment” — recalling the chaos that followed the collapse of US investment bank Lehman Brothers 13 years ago — has gained traction. But given Beijing’s influence and vested interests, the analogy does not easily fit.

“Unless China’s regulators seriously mismanage the situation, a systemic crisis in the country’s financial sector is not on the cards,” says He Wei, an analyst at Gavekal, a research company.

Security personnel form a human chain outside Evergrande’s headquarters in Shenzhen, where people gathered earlier this month to demand repayment of loans and financial products

Security personnel form a human chain outside Evergrande’s headquarters in Shenzhen, where people gathered earlier this month to demand repayment of loans and financial products © David Kirton/Reuters

Indeed, the main cause of Evergrande’s crisis and the downturn in the broader property sector is Beijing itself.

In summary,

"Wright says the property sector is becoming a threat to financial, economic and social stability — it has already sparked protests in several cities. “It is very difficult to provide a compelling narrative that China’s potential growth will exceed 4 per cent in the next decade,” Wright adds.

Miller echoes that sentiment. “We are set for a roller-coaster ride in policy and in economic growth,” he says “I would not be surprised if a decade from now GDP growth was 1 or 2 per cent.”

The stupidity of some journalists and economists is...stupefying. They keep pointing out that Evergrande's crisis has been "caused" by Beijing restrictions on debt. But Beijing has merely "HASTENED" or "BROUGHT FORWARD" the inevitable!

It is misleading in the extreme to say that the crisis could be avoided without Beijing's strictures. The fact is that sooner or later the bitter medicine has to be administered! So it matters not one whiff who lit the detonator...The bomb was going to explode in any case!

Ray Dalio is such a laugh! He sounds as bizarre as Keating...except he's many billions wealthier...But he still oozes CRAP from every pore when he pontificates on Chinese finance...That's the

meaning of "sound the trumpet" or "pushing your own wheelbarrow"...haha...

This blissfully short report in Bloomberg:

Dalio says Evergrande ‘manageable’ even as investors stung

Hema Parmar

Sep 22, 2021 – 2.56am

Save

China Evergrande Group’s debt crisis “is all manageable” even as lenders are hurt by the property developer’s troubles, Ray Dalio said.

“Investors will be stung -- that’s how it works,” Dalio, the founder of hedge fund Bridgewater Associates, said in an interview. “The system will be protected because it’s denominated in its own currency.”

Dalio has an estimated net worth of $US15.6 billion, according to the Bloomberg Billionaires Index. Bloomberg

Evergrande -- China’s largest property developer, with $US300 billion ($414 billion) of liabilities -- missed interest payments due on Monday to at least two of its largest bank creditors, taking the cash-strapped developer a step closer to one of the nation’s biggest debt restructurings.

Evergrande slid deeper in equity and credit markets on Tuesday, fuelling concerns about broader contagion after S&P Global Ratings said the developer was on the brink of default.

“China’s a strategic play -- you’re not going to jump in and out. And the amount that you’re in should be that which you’re comfortable with,” Dalio said. “It’s not smart to sell on the break, or buy.” While most investors are overweight the US, diversification is important given the “war of sorts going on in technology”, he said.

As China has cracked down on business sectors from tech to online education and real estate, investors have questioned the viability of investing in the country. But Dalio, who first visited China in 1984, has remained positive on the world’s second-largest economy.

RBA shows signs of nervousness over China.

RBA signals uncertainty over China outlook

Evergrande has become the poster-child of Beijing’s crackdown on debt-addicted property developers.

Evergrande is hostage to Beijing’s property pain threshold

Earlier this month, he said investors shouldn’t neglect China “not only because of the opportunities it provides, but you lose the excitement if you’re not there”. As for the market swings in Chinese markets, Dalio has described them as little more than “wiggles”.

Dalio has an estimated net worth of $US15.6 billion, according to the Bloomberg Billionaires Index. Bridgewater’s Pure Alpha II hedge fund has gained 1.4 per cent this year through August. The firm manages $US105 billion in hedge fund assets.

Here are some other highlights from the interview:

On bitcoin: The cryptocurrency has an “imputed value, not an intrinsic value”. If bitcoin is successful, it will be worth “a lot more” than the current value, which is less than $US1 trillion.

On quantitative easing: Dalio predicts more QE from the Federal Reserve down the road, after the upcoming tapering of its current asset purchases. He added that people holding cash will have negative real returns.

On performance: Dalio said Bridgewater’s All Weather fund is up about 10 per cent so far this year.

Bloomberg

And how is this for irrelevance from Bloomberg: "Evergrande to meet bond payments"!

Yes! All 46 million dollars of them on a tiny tranche! WHAT A JOKE! You call that financial journalism?!

The PBOC has just injected another $20 billion this morning...it does this every day! .... twenty billion here, twenty billion there...and pretty soon you're talking serious money! Hahahaha...

https://www.afr.com/markets/debt-markets/evergrande-unit-to-meet-bond-payments-20210922-p58tsx

Now, this is more like it from Bloomberg:

Evergrande meltdown ensnares stocks with very few China links

Vildana Hajric and Katie Greifeld

Sep 22, 2021 – 12.03pm

Save

A Chinese property owner in distress, and in short order the shares of American social media and auction companies are tumbling. The chain reaction may say more about the extreme altitude of global risk assets than it does about economic contagion.

While it does not require excessive sleuthing to understand why commodity and bank stocks are quaking in the vortex surrounding Evergrande, the link with a stock like Twitter or eBay is harder to see.

“You’ve got a whole basket of things to be concerned about – throw this headline into the mix and that throws everything askew. So, there’s going to be irrational de-risking taking place that doesn’t connect logically,” said Art Hogan, chief strategist at National Securities, of the Evergrande crisis. “Does it make sense for technology stocks to be selling? No, but in a risk-off scenario, everything tends to be for sale – even cryptocurrencies.”

Though there may not be an obvious connection between some US tech stocks and China, that does not mean the selloff makes no sense. Sky-high valuations have been bear fodder for months, and Federal Reserve hawks are circling. Evergrande may seem like a flimsy rationale, but Monday’s rout is similar in size to a half dozen other market plunges in 2021 that did not require any news to ignite.

In fact, investors took the opportunity to sell in a market that has been priced to perfection. The Russell 2000 Index of smaller companies, typically thought of as being more US-oriented and with less international exposure than the S&P 500, led declines, falling as much as 3.6 per cent on Monday. An index of regional banks, stuffed with companies such as Bank of Hawaii and PacWest Bancorp, lost 3.9 per cent at one point.

The iShares MSCI Emerging Markets ex-China ETF fell more than 2 per cent, while Twitter, which is not directly accessible in the country, lost more than 4 per cent at one point. And companies only operating in the US, like supermarket chain Kroger also dropped.

In other words, lots of assets are getting embroiled in the selling, and “I don’t know that that’s entirely appropriate,” said Hogan.

Still, the word “contagion” is being thrown around due to Evergrande’s size. The Chinese real estate developer has about $US300 billion ($414 billion) worth of liabilities, more than any other property developer in the world, Bloomberg has reported, and it accounts for about 16 per cent of outstanding notes in China’s high-yield dollar bond market. Though concerns over the company’s ability to service its debt have percolated for weeks, those concerns came into greater focus this week with some $US83.5 million of interest on a five-year dollar bond coming due on Thursday for the firm.

But investors are also contending with plenty of other worries: weakening earnings forecasts, a slow shift in Federal Reserve policy, uncertainty in Washington and more.

“With the high valuations, the Fed meeting tomorrow, we have a perfect storm for a very difficult day today,” Katy Kaminski, chief research strategist and portfolio manager for AlphaSimplex Group, said in an interview on Bloomberg Television. “For us, it’s much more of an underlying problem that is much more economic in nature and pervasive as opposed to something simply financial.”

Not all of Monday’s tumbles were without reason. A Goldman Sachs basket of Russell 1000 companies with the highest sales exposure to China fell as much as 3.3 per cent during the session, its worst day since mid-May, while another focused on stocks that are exposed heavily to supply chains in the country – also tracked by the bank – dropped 3.7 per cent at its worst.

Jerry Braakman, chief investment officer of First American Trust, said that it also made sense that commodities like copper, iron ore and crude oil would decline.

“China is still a huge demand-driver for basic commodities because they’re doing all the manufacturing for us,” he said. Mr Braakman also singled out some of the tech giants, including Apple and Tesla, with big China exposure. Apple in 2020 booked roughly 15 per cent of its revenue in China, a figure that clocked in at 21 per cent for Tesla, according to data compiled by Bloomberg.

To Gene Tannuzzo, a portfolio manager at Columbia Threadneedle, it was logical that names tied to China’s property sector and related commodities would be hit, so he and his team are watching slumping iron ore prices. “If other commodities follow it lower – oil, copper – that is generally correlated with weaker returns for US high yield,” and the latter still suggests the risk of contagion is low, he said. “Everything is a little softer today, but none of those charts look like iron ore yet.”

Iron ore futures have tumbled almost 60 per cent since a record in May.

Wells Fargo Investment Institute senior global market strategist Sameer Samana is also looking at high-yield spreads for an inkling of whether a contagion is at hand. To him, the sell-off in US stocks is much more about extreme positioning and a relentless buy-the-dip mentality that may have cut into sidelined cash that has typically been used during drawdowns.

“Until high-yield spreads in the US widen further, this should be viewed as an opportunity in US equities,” he said.

Bloomberg

You'd think with the Chinese Virus raging, people had learned the frightening meaning of... CONTAGION!

Gee...Janan Ganesh is growing up quick at the FT! I used to deride him as "Baba Ganoush" years ago (hahaha...a Lebanese chick pea and mushroom dip!...hahaha)... But here he has written perhaps his best piece of analysis ever! Worth reading...

Biden’s French snub is a warning to Europe

Janan Ganesh

The US was willing to bruise France to sign AUKUS for the same reason it was willing to upset much of Europe to leave Afghanistan. The priority is China.

The French approach to foreign affairs can be cold, one-eyed, chauvinist — and right. De Gaulle’s blackballing of Britain from the European project turned out to be prescient. Opposition to the Iraq war has aged even better in far less time.

Before the fall of Kabul, few nations were as quick as France to read the sad runes, and to warn its people there accordingly.

Joe Biden and Emmanuel Macron. Morally, the notion of decorum in the arms market is too eccentric to need spelling out. AP

In the shape of the US defence deal with Australia and Britain, France is enduring as cruel a snub as one democracy has dealt another for some time. If nothing else, though, its unsentimental view of the US — as Europe’s friend, not its eternal benefactor — stands enhanced.

It has been a good summer for the cause of “strategic autonomy” from America.

The US was willing to bruise France to sign AUKUS for the same reason it was willing to upset much of Europe to leave Afghanistan. The priority is China.

It is impossible for the EU to match and perhaps even to understand the all-consuming nature of this fixation. It is not defending a position as the world’s number one power. It does not — with respect to French Polynesia — have a Pacific coast. It has neither a reflex aversion to “communism”, nor mental scars from “losing” China to that creed in 1949.

Wall Street, it is true, has softened of late: there is too much Chinese wealth that needs deft management for a fee. But Washington itself is an even more bellicose place than when the superpowers exchanged tariffs in 2018. How quaint a mere trade war seems now.

And this, remember, is under a Democratic president. If Joe Biden is willing to spurn an ally in Europe for a smaller one in the right “theatre”, a Republican successor is hardly going to refrain. Nor is it obvious why they should.

Morally, the notion of decorum in the arms market is too eccentric to need spelling out. Strategically, the US is more than welcome in much of Asia, if only for fear of the alternative.

There is a strange notion doing the rounds that Biden’s foreign policy lacks coherence and — can you ever forgive him? — a “doctrine”. It is something said of almost every president at this stage of their tenure. It is less true of this one than any in recent times.

One theme connects his exit from Afghanistan, his grudging tolerance of a gas pipeline from Russia to Europe and his refusal to pick a fight with Saudi Arabia over sundry misdeeds. It is the minimisation of non-Chinese claims on US resources and attention.

When Biden is proactive — enhancing the Quad, which meets this week, or forming AUKUS — it is almost always in China’s region. There is nothing obscure or ambiguous about this strategic monomania. He is, if anything, coherent to a fault.

The mystery is all Europe’s. Will it accept the obvious about America? If so, to what extent will it make its own arrangements? The continent tends to blame brusque treatment from the US on the personal vagaries of its leader: cowboy George W Bush, aloof Barack Obama, feral Donald Trump.

Even as relations sour under a fourth consecutive president, it feels improper to suggest that the problem is structural.

For US purposes, Europe is badly located. While the Nazi and then Soviet threat made it the strategic crux of the world, the continent could count on geography alone to command a hearing in Washington. It now has to earn it through military brawn and a less fragmented foreign policy.

Yes, the first is expensive. The second is a political near-impossibility. For a sense of the alternative, though, the EU has the past month or so to chew on.

Starting with talk of “Anglo-Saxons”, there are glitches in the French understanding of the modern US. Even if the stress on bloodlines were not weirdly un-republican, it overrates how many Americans claim English ancestry. (The man who scuppered French dreams in the Suez Canal had that nice Wasp name, Eisenhower).

Nor is the quest to hold back US hegemony always kept in proportion. François Mitterrand referred to his nation’s “war without death” with America. Other French leaders have been less restrained.

Still, in the round, Paris gets the US more right than some easily mesmerised European capitals. It is a state with interests, as any other. It is not isolationist, just ever more Asian in its priorities.

Having such military clout, it tends to prize the same in other countries: an ally that brings little matériel to bear won’t be consulted out of good manners, as the Afghan farce showed.

The lesson here for the EU is plain, and it comes via a founding member’s bitter experience. How disorientating to be humiliated and vindicated all at once.

Financial Times

The Economics Forum 21

Commentary on Political Economy

Tuesday 21 September 2021

A FRANCISCAN FRIAR FOR ALL SEASONS

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