What a strange week. The governing Conservative Party in the UK has raised taxes to levels not seen since WWII and the Chinese Communist Party is limiting online gaming activity for children to just 3 hours per week. These are hardly populist moves and one does wonder whether these modern political masters of deception and deflection are steering domestic eyes away from two far bigger economic disasters? In fact, both potential disasters have a Celtic twist.
In the case of Global Britain and the Brexit fantasy, it was striking to see the UK fall out of the top 10 trading partners of Germany for the first time since 1950. The commercial carnage of Brexit is a clown car crash which can’t be hidden from UK tax payers for much longer no matter how many landmark sausage and cheese deals Trade Secretary, Liz Truss, and Sir Ian “Beefy” Botham land with Togo. Of course, our closest trading partner’s historic world-first attempt at a trade reduction treaty is not good news on this island but events in China may soon resonate even more strongly given our recent economic history. Remember the Celtic Tiger and an economy where almost 20% of activity(and government revenues) were derived from construction activity? Well, that tiger’s Sino relatives seem to have found sanctuary in the Middle Kingdom.
Check out this week’s news on Chinese real estate construction giant, Evergrande. China seem happy to bash its own technology companies in recent months but Evergrande has been allowed to reset debt terms by the Beijing authorities. The numbers might explain why. Evergrande’s debt pile is more than $300 billion which is more than Ireland’s GDP back in 2008. That’s the official number. It is quite likely off-balance sheet commitments/liabilities would bring that number up to $600 billion which would put the developer in Lehman Brothers territory.
Arguably, in enterprise value terms(debt + equity), Evergrande, and its 200,000 employees plus 3.8 million jobs in its construction ecosystem, is in the top 10 biggest companies on the planet. And, it is bust. It also is not alone. A quick peek at the distressed public market prices of bonds issued by other Chinese construction companies would indicate another $300 billion of debt in troubled waters. Now we are into $1 trillion dodgy debt territory. It is no great surprise the Chinese authorities are offering “sanctuary” to this construction tiger by seeking renegotiated debt terms on its behalf. The ripple effect of a full-scale default would hurt the entire construction industry in China. But, this is where I am a little concerned debt quarantine or sanctuary for one company might not be enough. Consider the following:
- China is not in Celtic Tiger territory but a construction/real estate industry accounting for 16% of GDP (vs Ireland at 20% in 2008) is about 3 times what would be considered healthy.
- Property statistics in 2019 showed Chinese home ownership at 90% – actually 96% in rural areas.
- In 2019 20% of urban housing stock or 65 million residences lay vacant.
- 44% of mortgages according to 2019 statistics are for second homes. And 24% are for third homes….
- Loans to the Chinese real estate industry are difficult to quantify because the banks are only one part of the financing system. We may soon get used to terminology like shadow banking(non banks), trust products(investments) and local government finance vehicles(LGFVs) because these will be the dominos which could fall first, and hard. Estimates of debt in these entities are well over $10 trillion and much of it will be real estate related.
We need to watch carefully the impact of a potential asset fire sale at Evergrande. Pressure on real estate prices will have Celtic-type consequences; lending freezes, collateral calls, liquidity pressures, defaults and more selling. But no buying. This is not a Brexity blip in trade. For context, consider “Global Britain” is a $3 trillion economy. Now add $50 trillion to that number and you are close to a 2019 Goldman Sachs estimate of the total value of Chinese housing and developers’ inventory. And for those quibbling with out-of-date 2019 data points above and possibly citing pent up Chinese structural ‘demand’ for housing I will leave you with two rather important numbers to consider.
- Chinese population growth is zero %.
- The value of new housing built in China since 2019 is estimated at $3 trillion.
Yep, Global Britain and its centuries-old history of empire, industrial revolution and world wars won has just been built in the space of two years…..