Mark Twain famously claimed that “history doesn’t repeat itself, but it often rhymes”. Whether or not Evergrande—the second largest property developer in China— emerges as a ‘Lehman moment’ is yet to be determined. The world in the wake of a global pandemic and after decades of expansionary monetary policy, awash with debt. News headlines in the United States are questioning if Secretary of the Treasury Janet Yellen should mint a $1 trillion coin to prevent a debt default; the debt to GDP ratio in the EU sits at 92.5%; finally, Evergrande is highlighting a potential debt crisis in China. Time will tell which of these three major economies will give birth to what would be difficult to call a black swan event, as the signs of a debt epidemic have been there for some time. China’s economy is currently facing the potential repercussions of using leverage to build the strongest economy in the world, but the adverse effects could be troubling for many.
China is perhaps on the fastest trajectory to industrialize in history. Deng Xiaoping designated a small fishing village called Shenzhen as China’s first special economic zone in the 1980s; now, Shenzhen is home to 18 million people, the world’s 4th busiest container port and a direct competitor to Silicon Valley. Shenzhen, the site of the second most skyscrapers in the world, is also connected with other cities in China, such as Shanghai which holds the fifth most skyscrapers in the world, by high-speed rail or a quick visit to the airport. As such, it’s clear that China’s economic growth is both realized and personified by infrastructure.
Without companies like Evergrande, which offer both home ownership and housing to millions this miracle industrialization may not have been possible. However, this growth was predicated on cheap borrowing and massive spending. The timeline of borrowing to construction was so fast that many housing units in China are unoccupied, up to 20% according to Bloomberg. This is problematic to the cash flow and books of property developers, such as Evergrande. Moreover, a major caveat is that growth in the Chinese context is complicated as the state is heavily interwoven with the private sector to the extent that both could be argued to be synonymous. This has led growth to be coordinated but uneven, and potentially painful for both the public and private sector going forward.
Some financial pundits have argued that Evergrande is not a Lehman moment but a localized problem confined within the borders of China. However, this is a rather naïve approach. The world economy is more interconnected than ever, even in the wake of protectionist policies. Moreover, China’s response will serve as a signal to the rest of the world as to whether to follow a similar path to solve financial issues – this could have a profound effect on global spheres of influence.
How will the Chinese government act? Evergrande can be both a catalyst of impending crisis and indicative of a slowing overleveraged economy. China’s manufacturing indexes are all down on the year. Further, as previously mentioned, the supply of housing has outpaced demand. The Chinese government is fully aware and trying to ‘deleverage’ the economy to equalize supply, demand, and growth. However, historical rapid expansion has created a monster that may be impossible to contain without incurring collateral damage. The New York Times claimed that “China’s growth is slowing, and the government may have to work harder to rekindle it.”
Due to the strong relationship between big business and the state, Evergrande could be “too big to fail.” If the Chinese government lets Evergrande fail, it could cause ripple effects felt within both Chinese and foreign markets. If Evergrande defaults, and goes bankrupt, then other companies in a similar position are likely to do the same, and insurance companies, other financial firms, and eventually the whole Chinese economy could come crashing down as well.
If Evergrande is bailed out, it will be hypocritical to China’s goals of deleveraging. However, most importantly, China’s response will reveal their political economy model. The Chinese government has already restricted their tech industry to align more with the values of the communist party, rather than free capitalist markets. The Chinese government will need to make a choice whether to avert economic disaster through socializing the failure of Evergrande or will the government take the ultimate capitalist approach and let it fail.
China’s approach will set the tone for the coming decades. Evergrande has the potential to grind China’s economic miracle to a halt and stop growth going forward. China has too many overleveraged companies in key industries, and the fact that the government recognizes this highlights the potential scale of the problem. As western governments argue how much more debt to take on, with no contradictory argument hitting the headlines or policy debates, China is aware of a deep problem that can unravel their markets. The jury is out on whether Evergrande will be China’s black swan event. For now, it is most certainly an ugly duckling.