By Michael Every of Rabobank
It's Ever Something
On 23 March, the giant cargo vessel Evergiven got stuck in the Suez Canal and blocked it for six days. Obviously, this dominated global headlines. Even Joe Shmoe could see global supply chains were not operating efficiently because of their gigantism. Six days, six months ago: yet today bullwhip supply-chain problems are still passing through the global system in escalating waves. Evergiven was just a symbol for those who had not been paying any attention to the underlying ‘too big to sail’ problems it represented. These were decades in the making, and will be years in the solving; will involve lots of money; and because they will also involve a different way of doing things, we haven’t even started yet in most places.
Evergrande, a giant Chinese property developer, has also run aground. Suddenly everyone in markets knows who it is, and is worrying about it. It is huge, and its debts are equally huge: $300bn, perhaps more. The whisper is that this could be China’s “Lehman moment”. Even with Chinese markets closed until Wednesday, we are seeing knock-on sell-offs around the world. Naturally, the upside specialists are also out there: Bloomberg today suggests market panic makes a bailout more likely: I think that dynamic only works on the US fiscal policy front.
Indeed, within China there is a spectrum of possible government approaches to the crisis. At one extreme, ‘the Austrian’, where the pieces fall where they may. I don’t think any economy anywhere would allow that to happen. At the other extreme, ‘socialism for the rich’, where everyone gets to carry on as if nothing happened, which is what we have seen in OECD since 2008. That also seems unlikely. Indeed, the decision will be made against the backdrop of ‘common prosperity’, rooted in Marxist-Leninist theory, and which separates between ‘productive’ (manufacturing), ‘unproductive’ (services), and ‘fictitious’ (financial asset) forms of capital.
Against that backdrop, are we going to see an outcome that rewards markets for not having listened to Beijing’s warnings about housing being for living, not speculation, and the three ‘red lines’ for property developers (1. 70% ceiling on liabilities to assets, excluding advance proceeds from projects sold on contract; 2. 100% cap on net debt to equity; 3. cash to short-term borrowing ratio of at least one)? That seems unlikely. Yet are we going to see an outcome where the physical capacity of the company is wiped out, and everyone fired? That also seems unlikely.
The outcome is likely to involve serious pain for some markets --and management-- as we have already seen under ‘common prosperity’. However, a variety of bail-outs and bail-ins may ensure ordinary people are not too badly bruised. The industry and banking sector can be consolidated, and the tab passed to the PBOC. Evergrande itself can be renamed or repurposed: perhaps building “productive” social housing(?) – at the very least, operating under a tighter leash.
Yet as with Evergiven, Evergrande is just the symbol of far larger problems. Everyone knows that China’s property sector is over-leveraged, its households are over-leveraged, and that far too much ‘productive’ physical output is channelled into building empty concrete high-rise boxes as a ‘store of wealth’, despite the fact they crumble over time and the population is about to shrink. Indeed, the key question is what the Chinese growth model looks like after Evergrande is resolved. What do you do with the 30% of GDP and 70% of household wealth tied up in property if, under ‘common prosperity’, house prices must stop going up (even if they are also strong-armed from going down)?
It is a question that everyone is looking for an answer to. The West, with similar problems, has no idea. That’s why all we do is blow asset bubble after asset bubble, while burbling ‘Build Back Better’. Allegedly, PM BoJo in the UK thinks this a 30-year project: I doubt society has that kind of patience. In China’s case, the range of achievable state goals is far more immediate, and far wider, while the ideological imperative is far clearer. The problem is that what one might look to as a counter --more infrastructure, higher state spending, etc.-- has already been done à outrance unless China is to build a welfare state….by taxing whom? If not, how can one shift from a pre- to post-Covid fiscal deficit when one starts at a post-Covid fiscal deficit?
The risks remain that China is forced to embrace RRR cuts, rate cuts, an even larger fiscal deficit, QE, and indeed MMT – which it can achieve as long as it retains capital controls and a trade surplus. Yet as global supply chains shift ahead to prevent Evergiven problems re-emerging, keeping that trade surplus might mean a need for a lower exchange rate at some point, even if CNY is pretending to be a true reserve currency for now by not moving in a crisis as others do: domestic brokers reportedly no longer being able to provide FX forecasts underline the opacity ahead.
Yet more liquidity in the same system will just create new Evergrandes, just as more fiscal stimulus in the US without supply-chain restructuring will just see more Evergivens waiting in ports to unload. ‘The spice must flow’ – but *where* it flows will need to be directed much more carefully ahead, in both China and the US. Markets should be panicking about that, if anything: how we do things now is not how we will do them for ever and ever. (Amen.)
Meanwhile, as alluded to, in the US the fiscal cliff-edge is being heralded as looming just a day ahead of the oncoming Fed tapering train. Will the debt ceiling drop on us? Will fiscal stimulus pass in a watered down form after (read: because of) a market panic, as Bloomberg thinks re: Evergrande? Again, take a step back and see that markets are panicking about the political direction of where money will, or won’t, flow….and yet most market analysts and economists claim ‘not to do’ politics!
For the RBNZ, it is already enough for them to make clear they won’t be going 50bp next month, jus 25bp…if they go at all. Let’s see how our ‘it’s ever something’ problems play out before counting our unhatched Kiwis. The RBA’s minutes from September also underlined that its central scenario remains rates on hold until 2024. They have expensive submarines to help pay for now, after all!
Lastly, I have to share last night’s ABC interview with China’s Victor Gao as a sample of the current zeitgeist in this region. It is worth a watch in its entirety if you don’t live in the region: imagine if this was your prime-time TV slot last night. Gao was emphatic about Australia being “logically” targeted for a potential nuclear attack because it wants nuclear-powered submarines. Notably, he is correct in saying this threat is clear strategic logic. Yet geostrategists would point out that Australia wanting such subs is also clear strategic logic – of the need for a balance of power and deterrence against any threats. Also recall, this is happening as China lobbies Australia to support its entry into the CPTPP trade partnership - which would of course help Beijing prop up those soon-to-be-needed-even-more trade surpluses, structurally.
Realpolitik doesn’t change - ever. It just gets overlooked for long periods before it becomes obvious to even ‘always buy the dip’ markets.