Evergrande Is Only The Beginning Part 2: The Domino Effect

At the end of last year our editorial team wrote a synopsis on how the collapse of China’s largest real estate developer would send shockwaves throughout the Chinese economy and lead to domino effect of financial instability, we were right, so without further ado, here is part 2.

After years of systemic support to aid China’s overheated hobbling real estate market, it is now more than evident the market is collapsing in real time.  In any other place other than the People’s Republic of China, we would be referring to the collapse in its past tense, collapsed, however there is nothing normal about how markets work in the PRC.  State support in nearly all sectors of the Chinese economy relevant to party goals will continue, that is as long as the dam doesn’t break.

Evergrande Development (Source: Reuters)

 As the world continues to toss and turn amid the heating of geopolitical tensions of world powers, the latest COVID-19 variant to terrorize our sanity and push us further into being chronic hypochondriacs, there’s trouble brewing in the middle kingdom. Beneath the tip of Evergrande’s financial iceberg more Chinese real estate juggernauts are on the edge of default, a crisis that may cascade into a domino effect and knock down the material support that holds the fabric of theChinese economy together.  

Upon the introduction of the People’s Bank of China’s ThreeRed Lines policy to reign in the borrowing practices of some of China’s largest firms almost half of the 30 of China’s largest developers have breached the outlined balance sheet parameters set by Beijing.  If anything can be observed and compared from the west’s real estate fueled financial crisis of 2008, real estate is not just real estate, real estate creates its own economies of scale with the underlying dependencies being reliant on a core growth engine that being real estate.  

Beijing is left in the predicament of catching a falling knife.  China’s largest developers binged on debt to build developments to nowhere. Policy makers in Beijing allowed it because growth was good politics, it meant jobs, it meant the means to prop up the worlds second largest economy, and ultimately confidence backed currency that could buy global influence.

As Evergrande, China’s largest developer was making headlines for being on the brink of insolvency the greater systemic problem was being brushed under the mat.  The next five dominos have already begun to fall.   The mega-developers Modern Land, Country Garden, Sunac, Fantasia, and Yango signs of similar symptomatic insolvency are now obvious with the total debts ofChinese developers totaling over $5 Trillion (CN¥33 Trillion) a debt pile larger than the GDP of Japan, by comparison upon filing for bankruptcyLehman Brothers’ debts totaled $619 Billion. Furthermore, there’s the liabilities of local government financing vehicles(LGFV) that financed massive construction projects all across China from railways to theme parks to power plants, LGFVs that while government guaranteed could materially result in defaults in excess of $7.8 Trillion, that’s dollars not yaun, a figure twice the size of the German economy.

With the World Trade Organization major banks such as Bank of America projecting a greater slow down in economic activity for 2023, China’s already hobbling export and revenue engine will take a greater hit as western consumption from accumulated savings surpluses thin.  This will push even greater pressure on China’s weakened real estate market demand likely leading to higher default pressures.  With 70% of Chinese wealth tied up in real estate the asset inflation continue to abruptly flatten as demand for new residential properties has declined 21% YOY.  Property sales of 22 developers tracked byMorgan Stanley fell 29% in August alone. All of this data spells a decade of financial decline for China amid a aging population crisis and as its two primary economic dependents exports and real estate will be battered likely well into the 2030’s.  What was once an engine that helped fuel a decade of global economic expansion will now be an anchor, China believed it’s state driven economy would be a saving grace against the harsh realities of free markets it has however let a financial cancer go onto to affect the body as a whole rather than cutting off a limb to save the body.

Source: Brookfield Brief