Evergrande is all of China’s evils in one
Former Premier Wen Jiabao called China’s economy “unstable, unbalanced, uncoordinated and unsustainable” 14 years ago. It is not known if he predicted that China would one day be plagued by a huge real estate bubble, overinvestment, excessive debt accumulation and a precarious credit system, but it has come true. Evergrande has long been at the intersection of these imbalances. By bankrupting it, Xi Jinping shows that he wants to take the bull by the horns. As the economic bubble deflates, it will be replaced by a new economic system under his absolute command.
Prior to the global financial crisis, China’s growth was driven by rising exports and corresponding investment in factories and manufacturing. After the Lehman Brothers bankruptcy, Beijing launched a massive stimulus package, financed by borrowed money. In the years that followed, the economy was driven by increasing doses of investment and credit. Real estate has been at the center of this boom. After surviving many setbacks, he has gained a reputation for invincibility. As the title of a recent book put it, it was the “bubble that never bursts”.
Unlike most authorities, Xi was not won over. Real estate booms provide low-quality or “fictitious” growth, he said. In recent years, China’s return on investment has fallen and productivity growth (output per capita) has fallen to half its 2007 level. Xi also called the real estate boom a social divider. The development of the land has fueled public corruption, which Xi is trying to root out. The rise in housing has exacerbated inequalities – half of the world’s billionaires in the sector come from China – and excluded the youngest. Millions of investor-owned properties have been left vacant.
The pandemic has caused the market to skyrocket. Beijing issued “three red lines” which limited the use of leverage, and which ended up pushing Evergrande to the brink. Home sales have just fallen. It is a risky move. The value of real estate is 3.7 times the GDP, according to Stewart Paterson of Capital Dialectics. Much of China’s debt is secured by real estate. Almost a third of the activity is exposed, directly or indirectly, to the sector.
No country has ever deflated a housing bubble without experiencing a severe recession, often accompanied by a financial crisis. There are parallels with Japan. The total value of Chinese property (relative to GDP) is comparable to that of Japanese real estate at its peak in 1990. Credit growth in China was more extreme than that of Japan in the 1980s. After Tokyo increased rates to trigger the speculative frenzy, there was a serious banking crisis and the economy suffered a “lost decade”. At the same time, the declining enrollment has exacerbated the deflationary forces unleashed by the collapse of the bubble. China faces a similar situation.
But Beijing believes it is in a better position. Developers controlled by state and local governments are likely to take over housing projects from Evergrande and other private developers. Contract law will not determine how bad debts are settled: bad debts will be allocated through China’s opaque credit system and authorities will decide who absorbs the losses. It will help if the country has relatively limited exposure to foreign creditors.
The economy will almost certainly slow down as the bubble releases air. It is often said that the legitimacy of the Communist Party government depends on its successful growth. But the Secretary General is more interested in “resilience” and “common prosperity” than in GDP goals. Its main objective is not economics, but national “rejuvenation”. Xi is prepared to sacrifice immediate growth. Its position is strong enough to face the vested interests that will suffer the most from the collapse.
In addition, he has a vision of the future. Its China 2025 plan aims to establish Chinese domination in technologies such as artificial intelligence or robotics. A social credit system will complement conventional credit. The official digital yuan will complement, and perhaps even replace, conventional currency. The country’s structure will become more digital. Big data, fed by the internet and hundreds of millions of public cameras, will support Xi’s surveillance firm.
Western investors have a lot to deal with. The immediate impact of the housing decline is deflationary. The change will reduce the global demand for raw materials. If the central bank prints money to alleviate debt problems, as seems likely, the yuan could suffer on foreign exchange. Capital flight could put more pressure on him, but if China dumps its surpluses of cheap goods into the rest of the world, trade tensions resurface.
The country is becoming more and more dangerous for foreign investors. Beijing’s recent treatment of listed technology and education companies shows that all companies must put the interests of the state ahead of shareholders. As debt problems surface, foreign creditors will find themselves at their wit’s end. Last week, when Evergrande defaulted on its foreign creditors, it was reported that interest on its domestic debt had been renegotiated.
The period of “reform and opening up” that began with Deng Xiaoping rekindled the “China Dream”, the old idea that the demand of the country’s huge population would generate great benefits for foreigners. This dream is dead. Instead, Xi talks about the “Chinese Dream,” a collectivist project that exalts the nation-state and puts the party under full control. Socialism with Chinese characteristics is starting to look a lot like the communism of yesteryear. Only this time their technology is more advanced.