Grand as Ever | Learning by Proxy
China is playing a game whose rules we need to grasp first
Say, you had a sudden windfall of a million dollars. What would you do? You might save some. But in all likelihood, your consumption would rise. Now instead of a one-time windfall, let us say you were going to get a salary of a million dollars. It would send your spending (consumption) to another level. Your spending would create jobs for others. Say you wish to eat at a fancy restaurant, it creates work not only for the cook and waiters at the restaurant but also for the suppliers and the farmers who supply the restaurant.
For a government, aiding the rise of a particular industry to rise can create many ripples of jobs downstream. Hence most governments identify specific industries that have the highest potential for job creation and support through their tax rebates, grants, international lobbying, etc.
For those who have been watching the rise of China with awe, real estate has been that industry along with manufacturing that has created jobs and caused the country to rise and rise. Their building and infrastructure have always been shown off for their speed of development and quality. The trouble is nobody bothered to ask how does a country manage to create as much real estate as the entire county of the United States in a mere 20 years? How did they finance it? And more importantly, how did they find that much demand so quickly? (They did not)
When Anne Stevenson-Yang lived in China in the 1990s and 2000s, she went on long weekend bike rides from her home near the airport, and she’d see the ghost towers: “an endless inventory of office parks and apartments, all empty.” She saw more developments mushroom after she moved to the US in 2014, when she made monthly work trips to China. As the co-founder of J Capital Research, which publishes reports on Chinese listed companies, she was intrigued by these projects. At first, she thought: If there were so many empty new buildings in Beijing—a city of high demand for housing and high incomes—what was it like in other places? On her travels through China, she saw ghost towns all over. She took photos and put them up on a web site, calling the images “Eye candy for pessimists.”
These unoccupied buildings, Stevenson-Yang realized, were the most visible signs of a swelling real estate bubble—the bubble that China has been attempting to control, and that has led to a danger of default by Evergrande, one of China’s biggest property developers. Over the years, Evergrande has run up around $300 billion in debt. In a 2017 interview, Stevenson-Yang called it “the biggest pyramid scheme the world has yet seen.” But Evergrande’s troubles were obvious even 10 years ago, Stevenson-Yang told Quartz. “It’s just been holding on, somehow, for 10 years.”
Source: Quartz
China allowed these ghosts towns to rise funded in part by Chinese banks because they were creating jobs. It made China and the Chinese govt look good. It brought a lot of foreign capital to China.
We all have heard of the ghost towns in China, nobody bothered asking who was paying for it? Turns out, Bondholders.
Evergrande has over $300 Billion in debt and now the interest is coming due and the company has been failing to pay any interest throughout this week.
The Chinese government, in the meantime, has been ready to throw any and all businesses to the wolves. We have watched the country purposely sabotage so many of their tech giants, they are not going to blink for a real estate company. To tell the truth they are making it harder.
First, recent comments by the editor-in-chief of the Global Times, a state-controlled publication often viewed as the Chinese Communist Party's mouthpiece. "Once the problem explodes, the enterprise cannot have the fluke of being 'too big to fail,'" he wrote on WeChat. "They must have the ability to save themselves."
"Blind expansion, reckless financial manipulation, and high leverage are all adventures that require smooth wind and luck," he added. "Evergrande stretched the rubber band too tightly."
Aware of how much debt that companies in the real-estate sector were amassing, China last year developed a system to curb perilous borrowing, dubbed the "three red lines," under which property developers since last August have had to ensure a liability-to-asset ratio of under 70%, a net gearing ratio of less than 100% and a cash-to-short-term debt ratio of at least one. Failing on the wrong side of these lines, companies like Evergrande would be restricted from borrowing more money.
The message to real estate developers was clear: It's up to you to get your act together.
Source: CNET
While the failure of Evergrande is bound to hurt several bondholders and rock the confidence in the Chinese economy and cause several investors to take pause; there is a much stronger undertone at play here. I had mentioned this in my blog the Chinese Suicide as well.
Several Apple Inc and Tesla Inc suppliers have suspended production at some Chinese factories for a number of days to comply with tighter energy consumption policies, putting supply chains at risk in the peak season for electronics goods.
Two major Taiwanese chipmakers, however, said their China facilities are operating as normal.
The development comes as tight coal supplies in China and toughening emissions standards have triggered a contraction in heavy industry in several regions, dragging on the country's economic growth rate, analysts have said.
Source: Reuters
After years of being the manufacturing hub for the world and having played by the 'Capitalist rules' set by the west; China seems to have decided that they are going to play a different game. The West outsources all of their pollution to China and wishes to hurt them with Carbon taxes. The pollution which is being generated on behalf of the western markets is becoming an albatross around China's neck.
This coupled with the increasing hostility between China and US, UK, Australia and the rest of Europe implies that China no longer wants to play the 'Capitalism game'.
In the movie Prestige, the character of Alfred Borden says - "Well, maybe I'm just biding my time. [produces a red rubber ball] Maybe one day, I'll hold up my hand, get your attention, ask, 'Are you watching closely,' maybe a magic word or two, and then I'll be GONE."
Evergrande is just collateral damage in the process, it is the hand meant to grab the attention. The real action is somewhere else!
China has existed for thousands of years before America, Australia, UK or any other country in Europe has existed and thanks to the Lindy Effect it would likely exist for thousands more. They can afford to play this game by their own rules. But that starts with wiping the slate clean.
Whether it is killing some of the tech businesses or letting some of their largest, but more poorly run businesses, die; China seems to not care about the consequences in the short term. The question that all of us should be asking is what is the long term plan. It certainly seems to be to move away from the dance of capitalism; but what next?
Gambling is in the DNA of Chinese and is accepted culturally too. So, loose some, gain some is their way of life. Europeans will never figure that out.