The Peter Zeihan Podcast Series - The Chinese Housing Crisis: Evergrande’s Bankruptcy || Peter Zeihan

Episode Date: January 31, 2024

Evergrande, formerly China’s largest property developer, has just declared bankruptcy and the fallout is going to be massive. Let’s look at how we got to this point and some potential paths forward. Full Newsletter: https://mailchi.mp/zeihan/the-chinese-housing-crisis-evergrandes-bankruptcy

Hey everybody, Peter Zine coming to you from Colorado. The big news over the weekend is that a Hong Kong court has ruled that China's largest property development group Evergrand is bankrupt and needs to be broken up. This is something that the Chinese government has spent a lot of effort on the last two years not happening because, well, let me give you a little backstory. So there's two big things that dominate the Chinese economy. The first is something I call hyper financialization. the idea that the government both de facto confiscates the savings of the citizen population, so it can only go into projects funded by Chinese state banks, as well as massively expanding the money supply to a tune of like almost triple what we have here in the United States,

in order to make sure that there is plenty of cash sloshing around in the system so that banks can loan anything in any amount at low terms to anyone at any time, because if they can do that, they can expand, expand, expand, higher, higher, higher, higher. And people who have jobs don't go on long walks in large groups together. It's a public stability, political control approach to finance. It's not about profit. It's about throughput, because throughput requires a lot of bodies.

Anyway, that's the goal. In that sort of situation, you get two things. Number one, you get companies like Evergrand who gorge on all this bottomless supply of debt to build, build, build, even if there's no demand. second, you get a population who knows that their private savings is almost worthless because the Chinese government is forcing them to keep it in the state banks. And they want to put it into a hard asset that preferably the state can't control. And if they can't get their money out of the country, then the next best thing is a hard asset in the country, which typically is property. So you get people pooling their private savings in order to buy condos. And each condo is typically owned by a different consortium of private individuals,

making untangling it. Also, you have somewhere probably in the vicinity of 1.5 billion units in the country that have never been lived in, never will be lived in. So you're talking about 100% overbelled conservatively. Some estimates say it's as high as $3 billion, which is just so far beyond stupid. Anyway, ever grand going down means that their debts aren't going to be serviced anymore, and the physical assets they have are going to be parceled up, and foreign investors are going to be coming in to seeing what bits that they can get. None of these things are things that the Chinese Communist Party would normally allow to happen. So, there's a couple ways that this can go. None of them are good.

Option number one is we follow a Western-style bankruptcy and restitution program where this system is broken up, and a lot of their assets are sold at pennies, maybe dimes on a dollar, and it just goes away. If that happens, we will have a very clear idea of just how much the oversupply in the market is, and you can count on private citizens being up in arms. Probably, I mean, the best estimate I've seen out of China is that 70% of total private savings is wrapped up in real estate. And most of these assets are worth no more than 10 cents on the dollar. So if you have a fire sale of the single largest player

which controls one sixth of the market, holy shit, things are going to get real very, very, very quickly. Option number two is that the Chinese step in and abrogate the Hong Kong ruling. Now, legally, this cannot happen, but the Chinese Communist Party is not really big on legal details when it comes to Hong Kong in particular. And I have no doubt that they could stick their noses in that. If that happens, that Evergrand goes on some sort of state drip and everything with the system just kind of limps on, with the understanding now that Hong Kong has no legal authority over its own holdings, which will start an exodus of what few international firms are still there. Regardless how this goes, don't expect anything in the market to get better.

This is not like, say, the TARP program that the United States put into place back in 2008 at the bottom of the subplime crisis, which kind of froze the market and put a floor under things and allowed for reforms and economic growth to eventually heal the damage of the subprime crisis. No, no, no, no. This is a one-off decision that is not just holding back one rock from rolling down the hill. Evergrand may be the biggest player in this market, but it is by far not the only one who has been doing stupid things like. this, building condos that have no demand or running it like a Ponzi scheme, every development company in the country basically operates this way, and the second and third largest players in the industry are state-owned. So you can count on the Chinese government not using this as an opportunity to break with the old model and put into place something sustainable. And even if,

all of a sudden, this place were run by a bunch of Austrian economists, it's too late. How housing demand, legitimate housing demand, housing demand for houses that people actually live in as dominated by people age 20 to 45, people who were starting out. Well, 45 years ago, the Chinese government instituted the one child policy. You combine that with the most rapid urbanization program in human history, and there are no longer enough people under age 45 to do anything that is consumption-led, including home buying. So there is no path out of this that follows any pattern that we have established in a market environment, which leads us to political and social outcomes where the market economics are just atrocious and getting worse

by the day with a government that is becoming ever more nervous about the state of the economy and the loyalty of its population. I don't want to say anything overly dramatic as like, this is where it all starts to fall apart because we've had a lot of things like that go down in the last 18 months. But this. cuts to the core of what enables the average citizen to actually support the government. And there's no way we move forward from this without a lot of side damage.