Commentary on Political Economy

Monday 27 September 2021

 Opinion: The danger isn’t that China’s Evergrande will collapse. It’s that it won’t.

A resident walks through the Evergrande community in Wuhan, Hubei Province, China, on Sept. 24. Evergrande, China's largest property developer, is facing a liquidity crisis with total debts of around $300 billion. (Getty Images)
Opinion by Megan McArdle
September 25 at 9:00 pm Taiwan Time
Have you heard about the crisis at Evergrande? After weeks of rumor and speculation, the Chinese real estate developer has finally missed payments on its dollar-denominated bonds. The company is not technically in default yet, but Chinese authorities have asked local governments to start preparing for the firm’s implosion.
Perhaps you are wondering whether we should prepare, too, having read nervous-making headlines about how Evergrande might be China’s “Lehman moment.” But it is unlikely that we will see a local Chinese financial crisis on the scale of 2008, much less that such ills will start skipping from continent to continent.
The bigger risk is that China won’t have the hour of reckoning its economy badly needs.
It is of course possible that an Evergrande collapse will touch off a contagion beyond even the mighty powers of the Chinese government to control. But, more likely, Evergrande can’t fail, much less touch off a Chinese recession, unless China’s President Xi Jinping wants it to. Still less likely that it will cascade to the rest of us, because, by design, the Chinese financial system is walled off from global capital markets.
Domestically, various levels of government can exercise control over deposit rates and who gets loans. Those governments have a keen interest in keeping employment and property prices high, not just because citizens prefer it but because property sales have been providing a big chunk of local government budgets, particularly during the pandemic. So when property prices stumble, or bankruptcy looms, China faces the temptation to pump more loans into the system to keep everything afloat.
Unfortunately, that doesn’t make the losses go away; it just hides them under new debt. Underneath, the fissures keep getting wider and deeper.
Issuing new loans to enterprises that would otherwise go bankrupt — and should — locks you into a cycle whereby ever-increasing amounts of capital are diverted from promising new opportunities to old, inefficient, politically protected sectors.
It also contributes to China’s epic property boom. China’s strictly controlled banking system doesn’t offer very good rates on deposits — someone has to pay for all those nonperforming loans — and the Chinese stock market is still in its infancy. Add in tight capital controls that make it difficult to invest abroad, and Chinese savers have few good places to park their cash, except for real estate. China is littered with “ghost cities” of unwanted apartment buildings, along with empty “ghost apartments” held by speculators. A 2019 report estimated that fully 20 percent of apartments in China were unoccupied.
Even those that are rented aren’t necessarily generating much income. When you look at the buy vs. rent decision in China, “hands down it’s cheaper to rent,” says Patrick Chovanec, an economic adviser to Silvercrest Asset Management and adjunct professor at Columbia University’s School of International and Public Affairs.
America has some experience with what happens when people start treating homes as ever-appreciating capital assets rather than places to live. But in China there’s another difficulty, says Chovanec, because even nonmortgage loans there tend to be secured by real estate, which will deepen any contraction if property prices collapse.
All of this gives Xi an unenviable choice: Modernize the banking system, recognize the bad debts and weather a nasty contraction — or put the problems off for another day, perhaps hoping to discourage the worst speculative excesses by punishing Evergrande’s chairman. But Evergrande is just a symptom of much wider problems in the economy, and Chovanec is skeptical that this can be changed by making an example of Chairman Hui Ka Yan. The heads of many other companies, he says, are “already so deep in the hole, there’s not an option for them to be scared straight.”
For years, China has fitfully been trying to put its financial house in order, then backing off as the scale of the potential disaster became apparent. It seems more likely than not that we’ll see a similar pattern now.
And what of it, you might say? The economy is still growing. But the export-led growth model that fueled China’s rise can only work for so long. World demand could absorb China’s excess production when it was a relatively small share of world gross domestic product. But with the world’s second-largest GDP, it needs a balanced economy that generates robust domestic demand. America and Western Europe aren’t going to start buying three times as much of everything, and China still has a major income gap to close before it truly joins the developed world.
Sometimes, says Chovanec, “the only worse thing than having a recession is not having one.”
Developing local demand will mean funneling capital away from asset-heavy manufacturing businesses and toward sectors such as retail, health care and logistics. That can’t happen until China develops a more modern, open financial system. But getting there will mean a brutal reckoning that the Chinese government would very much like to put off.

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