Evergrande Doesn’t Look Evergreen

Good morning on this fine Thursday!

We’re almost there.  I, for one, am looking forward to a restful weekend.  Classes this week go well, but it’s the end of a long summer graduate season.

 

That’s when I like to collapse on the couch for a few days.

In the meantime, rumblings on this side of the world in the Middle Kingdom’s real estate have Western commentators thinking, “Maybe if they have a Lehman, we can feel better about ourselves.”

Sorry, kids.  Ain’t happening.

As Mark Twain once said, “History doesn’t repeat itself, but it often rhymes.”

There’s no doubt in my mind China will have a financial crisis.  I just don’t think this is it… yet.

So let me put on my cap as your Far East Colonial Office writer and explain.

Evergrande: Not Grand, and Perhaps Not Evergreen

Last week, western investors rubbed their hands with glee as Evergrande, China’s largest real estate company, announced that it might default on two upcoming payments of $83 million and $47.5 million in interest on their outstanding bonds.

Evergrande generated $77 billion in revenue last year, so this shouldn’t be much of a big deal.

But cash is king, and they don’t have much of it.  They’re also loaded with $300 billion in debt already.

Of course, the markets took a big hit, but Western political commentators were thrilled, proclaiming this China’s Lehman’s moment. It doesn’t look like that.

Yet Another Unwieldy Conglomerate

A big problem with Evergrande is that it’s not just a real estate company. It has over-diversified, like so many big companies when they run out of ideas. 

I mean that when companies get too big and they run out of projects to invest in, they start diversifying into areas with which they have little acquaintance. 

Warren Buffett always warned people to stay inside their circle of competence. Evergrande has expanded into electronic vehicles, soccer teams, and bottled water, none of which do with real estate. 

Again, this is just trying to put their money into projects they think will give them some sort of decent return where the real estate market was already saturated. So this makes it an even bigger problem. 

If I were Evergrande, I’d try to divest all the stuff that has nothing to do with real estate first, then steady their position.

But we’ll see how this goes, and we’ll see just how much the CCP is willing to give them breathing room for them to bail themselves out.

The Consequences of a Bust in China

First, Evergrande, if it does go bust, will have the effect of being heard around the world. There’s no doubt about that.

But it will almost certainly not be as ruinous as the Lehman debacle back in 2008. And the reason for that is virtually no one trades Chinese “paper” outside of China.

Whereas in 2008, almost the entire world owned U.S. mortgage-backed securities. That’s why most investors around the world so keenly experienced the crisis. 

You must remember that the financial crisis of 2008 was a credit crisis and a liquidity crisis. The stock market selloff was the last thing that happened.

What started it all was the real estate market downturn, then the money markets wobbling, then the bond markets quaking, and then the equity markets crashing.

Lehman’s commercial paper default was a once-in-a-century event.  (The last time we “broke the buck” – money markets funds falling below $1.00 – was 61 years earlier.) 

Evergrande is a different kettle of fish altogether. Evergrande has been contracted by the Chinese government to build about 1.5 million homes in the People’s Republic of China.

The Chinese people are fiercely angry with Evergrande because they said they might not be able to do this. 

Interestingly, the CCP started acting like the capitalists they are all of a sudden, when they told Evergrande that the company itself must get its act together, and they will not receive a full-scale bailout.

Contrast this with the Western governments working “in concert” to “save the world” – or their pinstriped buddies, really – during 2008.  They saved everything on Wall Street but Lehman, which turned out to nullify the entire exercise.

What the CCP looks like it will indeed do is give Evergrande some breathing room on its debt. 

They’ll allow Evergrande to restructure the debt to make it easier to repay all their creditors, many of which are state-owned banks.

I guess we can say the SOBs will get some payback!

Crypto Isn’t Hiding Anything.

Interestingly, Bitcoin, Ethereum, and the other altcoins fell off a cliff in the past week.

Ethereum is now trading above $3,000, but it fell to $2,600.

Bitcoin is currently trading at around $43,000, far away from its $50,000 psychological safe zone.

And it rallied to $50,000 quite happily a couple of weeks ago.

This is all because of Evergrande and China’s economy. 

Now, the reason why I bring up crypto with regard to Evergrande is if crypto is taking that kind of hit just off of Evergrande, what kind of hit would it take if we’re going to have another global financial crisis? 

Here’s my hypothesis right now. This is not an anti-crypto rant, by the way. I’m still very pro-crypto. But I don’t think crypto has the levitation powers that most evangelists ascribe to it. 

That is, with all the debt in the world, I believe a lot of cryptos have been bought with levered cash by high net worth individuals with money borrowed from private banks.

These Lombard loans allow wealthy people to lever intensely against their assets and then take those funds borrowed and put them into crypto.

The problem with this is that it’s akin to margin buying.

When assets go down in value, what winds up happening is the old mantra, “Sell what you can, not what you want to.”

That is, even though people wouldn’t want to sell Bitcoin or Ethereum, they would be forced to sell the crypto on the back of what’s going on in China to cover any losses in another part of their portfolio.

This is not great for crypto. 

I don’t think crypto has nearly the hedging abilities against crashes that everyone thinks it does. 

In fact, the old aphorism, “Correlations go to 1 during crashes,” seems to apply here.  That means no asset class is spared during a crash.

Consider it a caveat emptor warning for those who have dipped their toe in. 

It’s just to let you know that crypto is an asset class just like every other one, and it has its fortes and foibles.

But to confirm: This is not a Lehman moment. It’s just a rather ugly moment that won’t sink the world economy.

Until tomorrow, have a great day.

All the best,

Sean

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