China’s Economy is Doomed

Sometime early last summer, Hui Ka Yan, chairman of Evergrande Real Estate in China, displayed his brilliant deal making abilities.  He took time off from developing and selling residential real estate buildings to sell China’s most popular soccer team to fellow billionaire, and chairman of Alibaba Group, Jack Ma.

“By accident I got him drunk,” recounted Yan, of how the deal went down with Ma.  “I told him my Evergrande soccer team is planning to issue shares and raise money to support strategic development, will you join?  He said I will.  We finished it in 15 minutes.”

Surely, such stellar business dealings have been fundamental in Yan accumulating a net worth of $6.4 billion.  Likewise, for Ma this $192 million soccer team purchase may have been nothing more than an act of philanthropy.  Ma’s net worth – $22.5 billion – dwarfs Yan’s.

One of the great marvels of life is the direction money flows.  From whose hand is it given?  To whose hands is it received?

For instance, money has flowed from west to east without interruption for nearly 25 years.  Thus for China’s new rich, their good fortune appears to be not merely cyclical, but perpetual.  But is it real…or a mirage?

Pumping Credit

Cracks in the foundation of China’s economy have become too large to throw an area rug over.  The symbiotic process of rising asset prices supporting larger and larger debt issuances, to further boost rising asset prices and further supporting larger and larger debt issuances, has broken down.  After years of increases, home prices in China have begun to fall.

Naturally, when a massive pyramid of debt is piled up on a cracking foundation, there’s bound to be some fallout.  Though, for a time, the money masters will attempt to suspend the fall and levitate asset prices by pumping massive amounts of credit.  Here’s what we mean…

“Chinese banks have extended $16 billion in credit lines to shore up one of the country’s largest and most heavily indebted home builders, as pressure mounts on developers short of cash in a slumping property market,” reported the New York Times.

“The move by a group of mainly state-run banks to bolster the builder, Evergrande Real Estate Group, which is controlled by the colorful billionaire Hui Ka Yan, is the latest sign of tumult in China’s sprawling housing sector.  Developers are rushing to secure financial support as sales volumes and housing prices plunge, weighed down by a growing overhang of unsold homes.

“Evergrande said on Tuesday that since February, it had secured new credit lines totaling 100 billion renminbi, or $16.2 billion.  Those included a new, 30 billion renminbi commitment on Monday from the Bank of China, which regards the developer as ‘its most important bank-wide long-term partner,’ Evergrande said in a news release.”

China’s Economy is Doomed

Brilliance in business is often mistaken for dumb luck.  Particularly when it is propelled by a central bank induced credit expansion and asset price bubble.  Just look at Donald Trump.  As the tide rises he appears to be a genius.  However, when it recedes he’s always caught swimming with his pants down.

It’s really quite simple.  When asset prices exceed levels that can be supported by the economy an adjustment is needed.  Units go vacant.  Prices must come down.  So, too, the egos of the big borrowers must come down too.

Hu Kai Yan may not care that the company he founded is on government life support.  He’s made a personal fortune placing big bets and riding the rising tide of asset price inflation.  But the rest of China will have to suffer the costs of socialized losses.

“Evergrande had total borrowings of 151.8 billion renminbi [$24.6 billion] at the end of June, the most recent figures available.  But that figure did not include an additional 44.5 billion renminbi [$7.2 billion] worth of perpetual bonds, so called because they have no fixed repayment date, which the company carries on its books as equity.”

No doubt, perpetual bonds are a work of financial insanity.  You don’t have to repay them and they are reported as equity.  Perhaps they can be borrowed against too.

The simple fact is the Bank of China’s in too deep.  They see Evergrande and other big Chinese developers as too big to fail.  Yet letting them fail is exactly what the Bank of China should do.

Unfortunately, they won’t.  In short, this is why China’s economy is doomed to slow and slumber along like the economies of the US, EU, and Japan.


MN Gordon
for Economic Prism

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