Global markets rocked last week after a Chinese company named Evergrande fell into what looks like a downward spiral into oblivion. Evergrande is – or was – the second largest real estate company in China. A few years ago, it was the most valuable real estate stock in the world. He’s also been involved in an eclectic mix of other businesses, from mineral water and electric cars to pig farming. He even has a professional football team. But recently he has had a hard time paying off a colossal debt, a huge sum 300 billion dollars value.
The history of Evergrande is bigger than a single company. This is China’s model of unsustainable economic growth, which has relied on endless investment and a mad debt-fueled development frenzy in recent years. This model has helped China soar, but the country is currently experiencing turmoil. Last week some alarmist watchers called it China’s ‘Lehman moment’ – a reference to the Lehman Brothers collapse that preceded the 2008 financial crisis – but China-focused economists Argue it’s exaggerated.
Nonetheless, given the interconnectedness of the global economy, investors remain concerned about the future of the Chinese economy. It is a nuclear reactor that fuels global economic growth. The problems there could have ripple effects around the world.
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We’ve decided to put together a little list on what we’ve learned from Evergrande’s history so far.
1) Real estate has played an important role in China’s economic growth
Vivian Lin / AFP via Getty Images
China’s economic growth in recent years has been fueled in large part by its roaring real estate market. The real estate sector, directly and indirectly, represents as much 29% of China’s total gross domestic product. This growth was fueled by a huge real estate bubble and increasing amounts of debt. For a while, national China and local governments used their enormous powers of command and control over the economy to keep the bubble inflating. As is usually the case with bubbles, investors and businesses have taken on massive debt to take advantage of soaring house prices. Evergrande has raised more than 300 billion dollars indebted to its banks, bondholders, suppliers and customers, many of whom pre-bought homes months, if not years, before they were built.
2) China’s real estate bubble has created spooky ‘ghost towns’ across the country
Greg Baker / AFP via Getty Images
The Chinese real estate bubble, which observers talked about for years, has encouraged more and more speculation, with investors buying properties with no intention of living there. Unfinished and vacant buildings and apartments litter the Chinese provinces. Estimates vary, but approximately 20% of China’s total housing stock is now unoccupied. The Financial Time said there are now enough vacant properties in the country to house over 90 million people. That’s enough empty houses to house the entire population of Canada. Or France. Or Germany.
In some cases, entire urban areas are empty. These “ghost towns” include replicas of Paris, Venice and even Jackson Hole, Wyoming.
3) The Chinese Communist Party is striving to reduce financial risks and change its model of economic growth
Kevin Frayer / Getty Images
One of the main differences between Evergrande’s debt tightening and the Lehman Brothers collapse is that the tightening was brought about on purpose. The Chinese Communist Party has been aware of the dangers posed by its wild real estate market for some time. In 2017, President Xi Jinping began signaling that he wanted to do something with a speech at the 19th Party Congress. He said, “Houses are built to be inhabited, not for speculation.”
Last year the government followed through on a policy known as “three red lines“, which aims to reduce debt in the housing market, crack down on reckless borrowing and prevent a market correction from turning into a cataclysm. Historian Adam Tooze call him “controlled demolition” of the real estate bubble.
More broadly, Xi is pursuing sweeping new policies in the name of “common prosperity“, an effort to fight growing inequalities in China and intervene more forcefully in private industries.
In July, Xi released a trial describing his ambitions for China. He said he wanted the country to focus on “pursuing real GDP growth rather than inflated growth and achieving high-quality, efficient and sustainable development.” Evergrande, a poster child for the excesses of the real estate market, apparently does not represent real economic growth. And government policies, which once spurred the business on, are now strangling it.
4) Cronyism may have lulled investors and creditors into overconfidence in Evergrande
Etienne Oliveau / Getty Images
Evergrande was founded by Xu Jiayin, who not too long ago was China’s richest man. Xu is well connected. He is a member of the Chinese People’s Political Consultative Conference, an elite group of government advisers. He is also politically savvy. For example, he would have led Evergrande to buy the Guangzhou soccer club after Xi said he wanted China to have a great soccer team. The company then sank millions buying some of the best soccer players in the world.
The New York Times suggests that Xu’s connections gave investors and creditors assurance that the company could continue to borrow and be bailed out by the government if things went wrong. They thought Evergrande was too big and too connected to fail. In August, however, as the business began to falter, Xu resigned as president of the real estate branch of Evergrande, sending it even further.
5) Evergrande may just be the tip of the iceberg
Kevin Frayer / Getty Images
China’s growth in recent years has largely depended on a gargantuan expansion of real estate and all of its amenities – trains, bridges and sewers. China has built, built and built, creating many economic activities. With Evergrande, this kind of growth is finally proving unsustainable – and the Chinese economy is going through a period of turbulence. The weird part is that it seems to be, in part, by design.
We still have questions. How forcefully will China act to contain the damage caused by Evergrande? Will China be able to succeed in changing its economic model away from real estate and endless development? How will this change affect the wider global economy? We will be attentive in the coming weeks.
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