Is China and the world heading towards an economic crisis due to Evergrande?

Is China and the world heading towards an economic crisis due to Evergrande?

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Hi, there. Today we're going to talk about the biggest time bomb that China is dealing with: Evergrande. Many of you have asked me in the comments of previous videos to make a little video about that. Well, that's what I'm doing right now.

I'm going to talk about this time bomb. Does this risk, this systemic crisis, that China is dealing with in the real estate environment. And I'm going to give a little bit more insights on Evergrande itself, how it all started; what it's about.

Are they going to survive? Yes or no? Are they going to take along a lot of other property developers? Will this create a financial crisis in China? Maybe a global one? What is really happening with Evergrande? Welcome to this week's Pascal's China lens. If you haven't subscribed to my channel yet, please do so. You'll enjoy a lot of videos on other crisis, problems, solutions, and technology and innovation coming from China.

Evergrande is a company we're going to talk about today; and since September, the whole world has been talking about Evergrande and how this company, the second largest real estate company in China, is on the verge of bankruptcy. And that means that they could actually create not just a bankruptcy for themselves, but also many other real estate companies could go bankrupt. It also means it could create potentially a financial crisis in China that could even go global. Just like we've known the financial crisis in 2008 in the U.S.,in America, that started there, also with a real estate bubble that bursted, and mortgages that could not be paid. And so a lot of people are comparing what happened in 2008 with what's happening now with Evergrande.

So, an important story to tell. So, if we want to understand this story, we actually have to go back in September. And this video is a little bit late, because I've been extremely busy the past two months to finish a book, a new book. I'm not going to talk about it yet, but in a couple of weeks from now, I will.

And I've been writing this second book because my first book was about China's new normal. It's called China's New Normal. It's about setting the standard for global innovation that comes from China. And this was all about technology and innovation. But my second book is a little bit different . But don't want to talk about it. Don't want to ruin the surprise.

But my first book, China's New Normal in one of the chapters called Finance and Insurance. In that chapter, I explain about four time bombs, and this is very relevant to the story today; because I was talking about the four big time bombs that China has that they need to keep under control or die defuse before they explode. This was about the debt of China, which is now 300% of GDP almost. It doubled since two thousand eight financial crisis. It's about the state owned enterprises, that are used as a vehicle to do investments and to figure out things in the economy that are not going well and to invest in the right places. And so, this is great from a governmental point of view, but often these

SOEs are not profitable or some of them are even bankrupt, but they're still operating because it's a vehicle for the government. And so that's also a problem. The biggest issue, of course, that we're going to talk about today is the real estate bubble, that ,seems to be bursting now. And then there's the social unrest that was that fourth time bomb, where there's still six hundred million people or more even that are not in the middle class of China and and are not surfing on the wave of the economic miracle of China. And many people are saying, yeah, if they get hit by certain challenges in the next years to come, there may be a lot of social unrest.

And why is this interesting? Because if you look at the Evergrande problem today, what you see is that all four aspects are actually related to this one story. It's about the debt of Evergrande. It's about SOEs that now need to figure out a way to bail out Evergrande to buy their assets. It's about the real estate crisis and the real estate bubble. I mean, if you think about it, real estate represents 29% of the GDP of China. 70% of the wealth of Chinese are in real estate, in apartments and buildings. And so that means that this is a huge part of the economic miracle that China has created, but also the wealth.

And so then there's the social unrest. Of course, if people can't get their apartments finished or there's people losing jobs, I mean, this is going to create problems. So all these four time bombs that I've been explaining in my book, China's New Normal are now on the verge of exploding. And so that's a big problem for China.

Now let's go into detail if we look at the founder of Evergrande called Hui Ka Yan or Xu Jiayin in Mandarin Chinese. He's someone that's early sixties now, and it's real miracle story. It's it's like something out of a fairy tale. He started very, very poor and and in 1992 moved to Shenzhen after 10 years of moving up through the ranks in a company he worked for and then started in 1996 Evergrande. So this is like 25 year old company, and the company just started growing, growing, growing. And right now, it's just before the summer, it was actually the second biggest

real estate company in China. He was the third richest person in China. Just before the summer, he was the 53 richest person in the world. So, I mean, the guy just went from nothing very, very poor in the countryside, very little village, 50,000 people to becom the 50 top richest people in the world. So a real fairy tale.

But then what does this actually mean and what happens with Evergrande? What is Evergrande, actually? Well, besides being the biggest or second biggest real estate property developer in China, with about 1.3 Million homes that are being developed right now, we're talking about 1,300 projects running right now, throughout 280 cities, cities all over China. So, this is kind of like a company, a property developer that is building cities everywhere. Also in Beijing, Shanghai, Guangzhou, Shenzhen, all the big cities. So, this is huge company, but it's not just about real estate.

The interesting thing is that this company also ventured into many, many other industries. I mean, thinking about industries like like pig farming, I mean, who would think about it? Water, bottled water, is one of their big companies that they're having with the mineral water from Evergrande. Then there's things like baby formula or solar panels. I mean, they went into so many industries, even electrical vehicles, Faraday Future, they have a past into that; and a new electrical vehicles. And then they even went into the entertainment business.

I mean, they owned together with Alibaba, the soccer team, or football team in in Guangzhou. Very famous, usually one of the top in China. But they're also in an amusement park called Fairyland and lots of other places. They have wellness centers. I mean, think about it, they are somewhere in there.

Evergrande is in everywhere. And then they even went into the wealth management and asset management and and lots of places when it related to finance. And so of course, this means just like Alibaba and many other companies that went in so many industries, that if one of them gets vulnerable, I mean, it also touches all the others. And so this has been a problem generally in China for many companies over the past years; venturing in just too many industries. But this is a huge, huge company.

Now, the problem is that they've grown so big that they have now about 300 Billion U.S. dollars in total debt, in outstanding debt to people (and banks). And so although, on the books, it's like a company that used to have, before the summer, they were saying about 500 Billion dollars in assets. And so the books were kind of OK.

More assets than than than liabilities. But the problem is that these debts are used to actually build or finish all these apartments. And so it's a huge amount of debt and a 100 billion of them is just bonds. So, loans that are given to them and they need to pay back all these loans every single month. Loans that expire or the interest on loans. And so these bonds for the past three or four months since September, were having a real problem to get paid back. And so a lot of people found out that a lot of investors, we're talking about 70,000 investors, figured out suddenly, that their money was maybe not going to get paid back.

And so this created a lot of problem. People went to the offices in Guangzhou of Evergrande and started really making a fuss and saying: "We need our money back!". And so, yeah, this is something that they couldn't pay back. And then if you look at the shares of Evergrande, I mean, they're really tumbled this year. It's more than 80% of valuation, or value, that went down because people were selling off their shares of Evergrande because of this whole mess that they're in.

And the problem with that is, of course, if your value is going down, it's very hard to get new loans and they used to have or need some new loans to pay back these old bonds that were expiring. And so how are they going to do it? What they started doing for the past years was to sell a lot of their apartments at discounts. I mean, this is not very good because if you sell at discounts, it means you're creating a new problem. But at the same time, what is the alternative? And so this is the situation of the problem that they're in.

They're not able to pay back those bonds, because nobody's giving them new money to finish the apartments, to get money from the people who bought these apartments. Big issue. Now, this is also a systemic problem in China, and I think it's important to touch on the real issue on the whole country. The biggest issue, in my view, is that local governments, throughout the whole country, for the past decade, decades actually, have been selling off land to get money in. So, when they need money to invest in all the things that China intended for them or the government, Beijing intended, or they wanted to actually change; and China has been changing like a real miracle. Well, they were selling off land and they've been selling off land everywhere.

The problem is that land is ending at one point. At one point, you have no more land to sell. But that also created that bubble because they were selling off land constantly; these property developers were actually buying all that land to then develop property to get people to go and live there. And so there was more property than actually there were people that were interested or able to buy these properties. So, there was a real big gap happening; but the land sale, or sell off, was actually one of the big issues still is today. And so now they need to figure out other ways to earn money.

And so the second thing has to do with the speculation of the Chinese. The problem in China, if you compare with the US, is that the financial markets aren't as developed as in America, like New York Stock Exchange, Nasdaq. I mean, this is very developed; and most Americans, most Westerners are investing a lot of money into the stock market because that's where they get great returns. Well, in China, they're investing a lot more into housing because the stock market isn't as developed. And if you just look at the past 20 years, I mean, it's not been the same returns as you would expect from a global stock markets.

And a lot of this has to do with a lot of companies, state-owned companies and so on that were listed but didn't get a lot of profit. And so that's one of the reasons, but the main reasons that our Chinese really want to buy houses because that's their way of feeling safe as well. The other big issue systemic issue is that there is actually very little write downs.

And so this is something in China; if you're in the real estate, you see very quickly that some of these projects, you can see them everywhere around you are unfinished or will never be finished or there's no investor for it anymore. Or it was just a fantasy building an amusement park, maybe that nobody visits. And so the problem is that all of these assets were not written down in the books as losses. And so when Evergrande says, yeah, we have like 300 Billion or 500 Billion in assets, well, maybe half of it, or I don't know how much, a big part of it, a part of it is actually assets that are not worth anything anymore. But on the books, it looks very good.

But if you don't write it off, I mean, the investors feel like, OK, you're doing OK, but reality is you're not doing OK, as soon as this gets out, this news. And so, the other thing is that systemic problem is that a lot of these companies, a lot of these real estate developers had started to create real liabilities, bigger liabilities than they actually had assets. And so last year, in September, the Chinese government says: OK, we need to figure out a way to solve this. And so they created a system, a model to to measure to see which companies like Evergrande were actually above, they call it the red lines. And there's three red lines; and companies that were beyond the red lines should be watched and should be restructured.

And this is about liability to assets that has to be below 70%. It's about the net debt to equity that has to be. This ratio has to be below 100%. And ultimately, the cash holding that these companies has has to be bigger than the short term debt that they're having, to allow to pay back the debts. And so, these were three lines.

And the interesting thing is that Evergrande, and a number of other companies were actually already in the red zone. So, in the danger zone. And so this is what people say is the tip of the iceberg.

It's actually much bigger this problem. And some companies say that two thirds of all the real estate, property developers in China actually at least have crossed one red line. And so yes, this is a systemic problem, and China needs to sort it now if we look at Evergrande again for a moment. Why do I say this could create a social unrest time bomb? And of course, the government will do everything they can not to make this happen, is because it's actually creating bankruptcies. A lot of suppliers for Evergrande.

I mean, we're talking about hundreds of thousands of suppliers, small and big, from design companies to to property builders, construction companies. They all have to finish these projects to get paid and they have to continue. And so if these projects aren't finished, well, they have no more job. We're talking about a lot of people that could go bankrupt or companies that could go bankrupt; which would also create a lot of unemployment. We're talking, in this case, about 3.5 million Chinese that are working directly or

indirectly for the Evergrande projects at 280 cities that they're in the 1.300 projects over the whole China. That's a huge unemployment that suddenly the government has to deal with; but it's also about people's money. And this has to do with the fact that many people have given deposits, money, to pay an apartment. I mean, we're talking about millions of apartments; and these apartments, these deposits. If they can't finish the apartments, they're not going to get the deposits back. I mean, that means for many of these people, their savings.

And so this is everything they've saved for their whole life and suddenly it's going to go away. And that means a lot of wealth losses in itself. But the wealth losses is also to do with the wealth management. And that means that they've invested a lot into the Evergrande wealth management funds; and so if they're going to go bust, everybody is going to lose out. So the problem and the scale of the problem that Evergrande could create for this just one company is enormous.

I mean, whether it's going to create a social unrest for the whole China, probably not. But it's definitely something that the government is very concerned about. Now, what's the solution? And for the past two months, we've seen a lot of things happening. First thing is that the government decided or it looks like the government is not going to bail out Evergrande. So, that's not going to be a solution for Evergrande. I mean, it would be easy. Beijing is just giving them a few 100 billion dollars.

Problem solved. They can restart again. That's maybe how the American model worked in 2008. That's not how Beijing model will work. China and Xi Jinping said very clearly, we're talking about common prosperity.

What that means is that we want to get these 600 million people from the poor people into the middle class. Everybody needs to have common prosperity and share the wealth. And so we're not going to help the rich people when they're in trouble, they have to figure it out themselves. Of course, we don't want to give problems for the poor people. That's what they need to do; and that's their responsibility. And so Evergrande will have to sell off all their assets or as much as they can, at least to pay back the bonds, to pay back the loans or the interest on the loans. And as soon as they can finish some projects, maybe they can earn some money again. But now it's all about selling the assets to make sure that there is no crisis

happening. And then what we also see is that a lot of these assets are getting nationalized. What we see is that companies like Vanke, or Wanke in Chinese, which are State Owned Enterprise companies, are starting to buy the assets of Evergrande. The football stadium is being bought by the Guangzhou government, and this is billions of dollars that it could be worth.

And so this could solve at least next year. 2022, 2023, maybe. And so, they're trying to figure out a way to sell off all the assets, to nationalize them, in order to keep everything afloat. But also and that's the interesting, thing the owners wealth, so Hui Ka Yan, his wealth. He needs to use it personally. And because he owns more than 50 percent, we're talking about almost 70 percent of the shares of this company, Evergrande.

I mean, he used to be one of the richest people in in in China at one point with 34 billion dollars of value, of worth, of wealth. Well, he needs to sell off everything he has . But now he has, like were estimated, about 7 .2, 7.6 billion dollars in wealth, but that's

still a lot of money. He could actually, for the next 2,3 years, probably solve all these bonds; although in April or March 2022, there's a 3.5 Billion bond due. So maybe not last that long anyway. But the reality is he's been selling off his private jet. 50 million dollars. He's probably going to sell off the Airbus that he has, like 200 million USD.

And so, if he takes it all together, it's about 1.1 Billion dollars that he's already started to sell off privately and from his company. And so yes, it's going to probably save the day for a couple of months, maybe a year. But that's not the only solution, but that's the way it's going to go. Now the question many people are asking: Is this company actually going to survive? Can they survive? And the answer is probably yes, but likely not. And so what does that mean? It means that they're selling off all the assets as a fire sale almost, at much discount. I mean, that's the big issue.

The discount is the issue, because they're selling it off at great prices for the buyer. It also means that they're not getting the same money as they should have to pay back all the liabilities they have. But at the same time, because the owner, the founder, was putting in his own money, it was starting to sell off a lot of things.

And some people found money to pay back the bonds for the past three or four times. So, the past three times all the bonds have been paid, almost on time, sometimes just the day before. And what that means is that this money comes from somewhere. Is that the government that somehow is figuring it out to buy assets to give them back? Does he have money aside or where's the money coming from? Is not very clear, but clearly it gave a sign that just last week on on November 23rd, the stock in Hong Kong just increased again of Evergrande because people felt he's figuring out this problem.

But the real thing what's going to happen is a restructuring; and a restructuring in China in this case really means that everything that's going to go bad, things that are worth nothing, is probably going to go away somewhere in one of or other State Owned Enterprise, and we won't really see it in the financial numbers or financial system; it's going to get hidden somewhere. But, the reason that China wants to do this is really to save the social unrest that could be created from this whole crisis. And so this is what we could call Beijing's invisible hand. Beijing's invisible hand is basically whispering in people's ears of State-Owned Enterprises: "Well, you should buy this asset from from Evergrande". And so, Vanke might buy a few assets; and then some of these assets that are worth nothing. Well, how about we basically figure out a way to to hide them somewhere in a state owned enterprise? They're going to have more losses, but we're going to deal with that; and it's not going to create a financial crisis.

And then for the people, they need their money back. So we need these properties finished. What that means is that they will ask some other property developers to finish these apartments. And so all that whispering, behind the scenes probably, is actually what

could keep everything afloat. And what that means is that Beijing's invisible hand is going to probably help Evergrande survive; not because they're giving Evergrande money or they're giving Evergrant a bailout, but really because Evergrande could actually continue its operation just to save the social unrest from the from the crisis that they've created. Now, is this going to create a global crisis? This is often a question, or at least a China, a crisis in China; economic crisis.

It's pretty clear that the GDP somehow will be affected by this directly or indirectly, because it's not just about Evergrande. I mean, there's a lot of other companies companies like Fantasia, China Properties Group, Modern Land. I mean, a lot of them, like Sonic Group. I mean, a lot of them are in in doubt.

Can they actually create or have have a similar situation or experience as Evergrande? And so this is the reality today. But I don't think it's going to be another Lehman Brothers moment, just like 2008, because as I said before, the big difference is with Lehman Brothers, it's all about the financial sector very often. And so this was kind of like a real bubble.

Well, in China, most people own their own house. More than 90% of the families in China have their own property, while in the U.S., it's more like 60%.

What that means, is that it could affect China, but on the other hand, the property is less worth at one point, but it's not going to completely tumble, and they can still pay the mortgages, and they own that property anyhow over time. So it's it's not the same effect as in the U.S. it's not the financial crisis that really is created by the stock exchange and so on, and financial investors like Lehman Brothers Company.

On the other hand, it's also not a Japan situation, and that has a lot to do with the fact that the state owned enterprises in China can cushion this crisis in a different way. And so in Japan, it was very, very different. And so we shouldn't compare this to the U.S. or to the Japan real estate crisis in the nineties, because these had different environments. They didn't have the situation of the ownership of of homes; they didn't have the situation of the state owned enterprises. And so that also didn't have the situation where the government could intervene in the same way. So I don't see this as a similar situation, but the most important for me is

to the other two things. It's the fact that this is not a surprise for the government. I mean, Lehman Brothers and a lot of things that happened in the US was really a surprise. Even in Japan, they didn't see it coming; but China saw this coming for the

past decade. They've been trying to figure out ways to increasing taxes on property. They didn't want this bubble to grow bigger, bigger, bigger. And that's also why a year ago, they put these three lines to just really know which are the companies in danger and how can we save them, or save the whole industry, and make sure it becomes more healthy? So, the decision or the reason that this bubble is actually slowly bursting is because the government created this burst themselves.

They actually wanted this burst in a certain way, because they wanted to make sure that these companies that were unhealthy became healthy, or stopped their activity, which is exactly what's happening with Evergrande. And for me, the biggest sign why I don't believe this will create a financial crisis in China, although it's a very complex situation, is because the government decided not to do a bailout. If they would really be worried about a huge financial crisis that could really paralyze the whole economy, I mean, 100% sure, Beijing would bail out Evergrande. Even if they've said to everybody, we don't want to do it, they would do it. Now they're doing it much behind the scenes.

But the reason that there's no bailout actually gives me some confidence that this is about creating a more healthy real estate environment rather than letting this bubble burst and then really tumble everything. But GDP will be affected; but this is not the first and top priority of Xi Jinping now anymore. What's the top priority. Is this common prosperity. And so GDP, yes, it will get affected.

In all, I would say Evergrande is going down and it's going down very, very fast and probably will go down all the way to zero. We don't know where it will end, but the value will never be what it was before. And many other real estate companies will follow. Many people say this is a domino effect, and I think in a way it is.

But I also believe that these dominoes are far away apart from each other to not actually knock the other one over. And so probably one after the other, slowly, is going to go down to the level where it's it's healthy. Prices of houses should be going down specifically, not maybe in the big cities, in the center, but in other places where the property has been way too high compared to the average revenue or wages that people have in these places. So everything's going to go down and the GDP will go down, but China will not go down as an economic crisis. It will be cushioned because of the state owned enterprises, because of the way that Beijing is handling it, and because of the way that everybody, even the founder of Evergrande, has figured out, I need to do my job, I need to do my part to keep everything afloat. And so he's putting his personal money, everything he's has, or as much as he can to save China.

And so that tells me that we're probably in for a bumpy right in the next years to come when it comes to the real estate, but it's not going to bring China down.

2021-12-02 09:48

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