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Evergrande: Big Trouble in China. A Big Threat to Global GDP

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Evergrande: Big Trouble in China. A big threat to global GDP.

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Miles Harris offers global macro insights and champions the importance of sound money in a world gone crazy. Subscribe to my channel on macro & metals: http://tiny.cc/16m5mz
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DISCLAIMER: Any advice given on my channel and videos is for information purposes only, and does not act as financial advice. Your financial decisions are your full responsibility, and if you are in any doubt, please contact a financial professional before undertaking any investment with your money or change to your financial activities.

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Now my last video focused on the dangers of financialization and this video really provides a case study of how the fiat standard has enabled enormous leverage and malinvestment to take place through real estate investing courtesy of Evergrande so let's dive on in now this channel provides global macro insights and champions the importance of sound money in the world gone crazy so please do consider subscribing now and it's the most indebted property developer in the world with its on-balance sheet liabilities reflecting around 2% of China's GDP first started in 1996 it was well placed to capitalize upon China's accelerated growth which was facilitated by means of joining up to the WTO in 2001. Evergrande benefited from China's real estate market with demand for homes in cities such as Beijing and shanghai sending prices skyrocketing the company took out a string of loans and expanded rapidly snapping up assets and making the most of China's thriving economy yeah as the company expanded rapidly from 2015 onwards the quality of its investments fell dramatically and as it leveraged up on cheap credit the marginal revenue productivity of its debt deteriorated substantially and the fall in property prices in smaller cities has hit at the same time that the Chinese government rolled out measures to curtail over the top property borrowing inevitably this left Evergrande in the lurch with mountains of debt and so really this situation has been brought about by President XI's desire to restore a more socialist order within the country capitalism was only ever seen by Xi as part of this journey on the road to serfdom the imbalances caused by financialization so clearly evident within western economies that we discussed in this video are clearly apparent in China and it appears that there is a real desire to undo some of these excesses moreover President Xi doesn't want any sort of competition at all just consider the case of Jack Ma who went missing after he had addressed an assembly of high profile figures with a controversial speech that criticized the Chinese financial system he was not seen in public again until late January in the interim there were rumors that he might have been placed under house arrest or otherwise detained more recently President Xi Jinping has called for stronger regulation of high incomes in august part of a campaign targeting China's largest technology companies is rapidly expanding to encompass broader social goals social goals originating from the origins of communism of course Xi Jinping has emphasized the need to regulate excessively high incomes and encourage high income groups and enterprises to return more to society the committee added that while the party had allowed some people and regions to get rich first in the early decades of China's reform and opening up period it was now prioritizing common prosperity for all, certainly there has been a desire to move the economy back to a situation of greater equality as the nation's Gini coefficient was at a similar level to that the US of 46.7, with the US at 48.5 indeed the financial and economic affairs committee has conducted an education crackdown saying that China must create more inclusive and fair conditions for people to improve their education levels many of these services could be offered now at a far lower prices or even face nationalization and so as regulators were asked to ensure that heavily indebted developers were monitored according to three red lines hard limits on debt to asset ratios constraints on debt to equity levels and ensuring sufficient cash to short-term liabilities these three rules meant Evergrande could no longer increase its borrowing as it was forced to pay down debt and to liquidate assets to build cash levels but Evergrande's story is very much China's story China has driven its debts GDP level up over 45 percent in the past five years and this has been crucial given China's politically determined GDP growth targets a good proportion of this GDP growth has been high quality growth but this has never quite been high enough to satisfy the CCP quality growth comes from higher consumption derived from increased earnings increased exports and business investment for productive purposes but to complement this high quality growth it has taken some residual or fictional growth originating from debt driven infrastructure and property investments initially this could be productive but increasingly leads to diminishing marginal returns after all how many bridges or how many blocks of flats do you need and the property sector contributes around 25 percent to China's GDP in an FT article source from Beijing think tank stated that stagnant consumption data has made clear that it's urgent to increase people's incomes and focus more on distribution fairness thus it really does seem plausible that there is a need to ensure affordability of housing and thereafter stabilize the housing market this would improve Chinese consumers ability to actually purchase their own homes of course Evergrande represents the potential for contagion with almost 300 billion dollars of outstanding debt this could easily spread to Chinese credit markets causing a credit card for companies facing maturing levels of debt but this could also provide an opportunity given the moral hazard that has previously existed given the implicit or explicit government guarantees that were encouraged by pursuing fictional and highly politicized growth targets large firms have typically enjoyed those from the Chinese government in addition wider economic contagion could spread to the real economy which could lead to an acceleration of any potential credit crunch together with the spike in savings collapse in consumption and complete risk aversion this is really Hemingway's gradually then suddenly approach to bankruptcy now it seems remaining funds will be used to complete housing projects rather than return funds to creditors this will help to actually prioritize future homeowners and forestall the possibility of further protests consequently foreign creditors were on the hook for substantial losses but of course investing in China always comes with great risk nevertheless China's financial system remains hidden behind a closed capital account which means the capital cannot easily be withdrawn from the Chinese financial system thus it's no surprise that Beijing's has decided to clamp down on any potential sources of leakages of Chinese RMB whether it's foreign currencies or most notably crypto currencies including bitcoin as we saw on Friday yet this closed system which has done so well in insulating China from previous crises and contagion risks such as the Asian financial crisis means regulators can intervene and force restructure liabilities to try to prevent further contagion I'd expect some sensible policies to be introduced here with by the people's bank of China taking on bad debts of the banking system and recapitalizing the banks so they can actually encourage and promote further lending this is far more preferable to the taxpayer-funded bailouts of companies we saw here in the west in 2008, additionally the rolling over of debts and ensuring that contractors and suppliers receive funds instead of the real estate paper provided by Evergrande this would help to prevent further fire sales which would destabilize the property market further but this whole situation will provide a further dent to global economic growth and damage those economies relying on commodity exports to China nonetheless China remains well positioned long term and this situation may actually represent a transition towards a more sustainable model with less of the excesses evident within the west time will tell thanks so much for listening do consider subscribing do hit the like button and I look forward to seeing you next time bye-bye

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