Evergrande's Domino Effect
How a possible bankrupt of Evergrande can impact the world's economy.
It’s not a big surprise for anyone that follows the market that China has a big problem right now, this problem has a name, and it is called Evergrande. With a debt of 300 billion dollars, their only way out is if the CCP bail out them. On September 17th the People’s Bank of China added 14 billion to the bank system, creating liquidity.
The housing market in China is being inflated for a long time, this is due to the fact that the Chinese don’t invest in the same way we do in the Western, they save money by buying real estate since there are not a lot of options to invest in.
It’s estimated that 70% of all wealth in posses of the Chinese is in the real estate market.
The bubble now seems to be on edge of the burst, which would implicate a domino effect, especially in emergent countries, like Brazil, Russia, and South Africa.
It’s worth remembering that their bonds, Evegrande’s bonds, were classified as AA, i.e, they were seen as good bonds to invest in. And in theory, it really was a “safe” investment.
The problem is that they seem to have ignored the leverage that the real estate market has in China, and Evergrande has by far the biggest leverage.
Just to set an example, Country Garden Holdings Company is the biggest real estate developer in China and their debt is 168 billion, with a leverage of 2,07x. It’s is high leverage but not as big as Evegrande’s.
This could also lead to a credit crisis in China since the expansion of credit in China is going down which is a natural move after a huge amount of credit.
Also, retail sales came at the lowest level since the start of the pandemic.
This also gives the signal that the economy in China will not have the same growth and that the GDP in China was inflated by phantom cities, where companies would construct buildings that no one would buy, but these buildings would increase the GDP number.
This could impact countries that have China as a major trade partner.
With an imminent deceleration in the Chinese economy, these countries will have an impact on their economies, especially those who export commodities to China, in particular, agricultural commodities and iron, like Brazil.
Companies that sell iron, like the Brazilian mining company Vale, are already feeling the impact of the drop in the iron price. Vale is -12% in the week, -14% in the month, -23% in 3 months.
The iron ore is down 33% since your top in June this year, 218 dollars was the highest price YTD.
So we can see that Evegrande’s crisis is already affecting other sectors of the economy, and that is Evergrande’s domino effect.
We can already see the markets in the whole world contaminated by Evergrande, we can expect markets to be volatile for a while, also commodities and crypto will be volatile (crypto already is but it can get even more).
But the question remains: what will happen to Evegrande? There are only 2 options, be bailout by the People’s Bank of China or go broke.
Let’s start with the scenario where Evegrande goes broke. I think my article made it very clear that it would impact the whole world. So what would happen is all I said above. A cascade of bad events would follow, the banks and the funds that have Evegrande’s bonds would have a problem, and they are already having since Evegrande is not paying the interest to their creditors.
We can already see a reflection of that in other real estate developers.
One of them, Sinic, wasn’t even able to appear on the chart above because their fall was -90%.
The Chinese Yuan is being contaminated. If we look at Yuan that is traded inside China and the Yuan that is traded offshore, the offshore has a premium in relation to the one traded inside China.
This happens because China has very restricted rules about the fluctuation of their currency.
The China 5 years CDS also had a peak, the biggest since September in 2020.
The private credit in China is also high yield, the biggest since March last year, and is considered a junk bond, i.e, it is a speculative asset.
If all of this already happened and Evegrande didn’t even go broke yet, imagine if it really goes broke.
The scenario where the People’s Bank of China bailouts Evegrande is a very likely scenario. Although it seems like the CCP doesn’t want to bail out them and wants to literally pay to see what will happen. Their dilemma is: if Evegrande goes bankrupt the population in China can get very unhappy and start some protests in China, which is something that the CCP would not want.
The problem for the people that hold Evegrand’s bonds is: are we seeing a Lehman moment? remember that until September 15th, 2008 people still believed that the FED would bail out them.
So, will China lose the moment to bail out Evergrande? will they calculate the risk of bankruptcy? will they add money directly on Evegrande? will the CCP let Evergrande goes broke and then rescue the banks in China since the majority of them belong to the CCP?
No one knows what will happen, it is worth remembering that China inflated the real estate market by expanding the credit through the government banks, tried to “unleverage” the real estate developers, and now we are seeing the consequences of the leverage they created.