After 18 months of intermittent lockdowns, market turmoil, yo-yoing infection rates, and a litany of mini-crises, a period of relative economic calm would be welcome. Instead, another crisis is looming in China, with Evergrande, the most indebted property company in the world, under severe financial strain and threatening to default. The broader market implications are yet to become clear, but there are echoes of the turmoil following the collapse of Lehman Brothers in 2008. An overheated property market, unserviceable debt, and a network of interconnected banks and businesses will all be affected if Evergrande fails. So, what might happen, how could it affect the global economy, and can safe-haven investments like gold help protect your assets from the fallout?
What is the Evergrande Group?
China Evergrande Group is a multibillion-dollar Chinese property development company with the largest real estate debt pile globally. It owns more than 1,300 projects across China. Their wider business also encompasses electric cars, a soccer team and food and drink manufacturing. Its aggressive expansion was funded by profligate borrowing of more than $300 billion, and it is now struggling to pay the interest on this debt burden. This week, a domestic bond interest payment and a US dollar bond interest payment are due, and it is unclear how much, if any, will be paid. According to the company, the former “has already been resolved through private negotiations“, although it is not clear how much interest will be paid. But there is no clarity on whether the overseas bond interest payment will be made this week or within the month’s grace period before it defaults. There are more repayments due in the short term as well.
China and Evergrande
Evergrande’s rapid and aggressive expansion reflected the wider Chinese focus on growth through construction and property development. It is one of the economy’s largest sectors, and any major slowdown in the construction and sale of real estate will have a wide-ranging effect across the country. In addition, the Chinese government, concerned about an oversupply of property and overstretched development companies, introduced stringent debt parameters, dubbed ‘the three red lines’, for real estate companies like Evergrande last year. This has clipped Evergrande’s debt wings and hastened the crunch it is currently experiencing.
Evergrande is one of the largest but by no means the only real estate company in China that will be affected by the change in direction implemented by the Chinese government. The ‘borrow to build’ strategy has been a staple of growth for years. However, in its efforts to curtail the overheated market, which is awash with unoccupied properties, there may be more Evergrande-style crises to come.
The Asian market responds
Markets have already responded to the potential collapse of Evergrande, falling sharply in Asia on Monday and dragging down international markets in the process. The company has lost over 80% of its stock value in the past year as concerns about China’s new real estate policies and the group’s debt mountain have grown.
The longer-term fallout is less clear. It will depend on whether the company can restructure its debt itself, and if not, whether the Chinese government will step in to ease the passing of the organisation, enforcing a restructuring that is possible because of the control the government has over the economy and the banks.
The news so far is mixed. The Wall Street Journal reported Thursday that the Chinese authorities had alerted local governments to prepare for the company’s failure. But shares in Evergrande surged 17% on Thursday following its deal to repay its local bond interest.
What is clear is a collapse would substantially impact Chinese consumers who have bought homes that they want built, suppliers and construction workers, and banks and investment companies exposed to a default. Such a large collapse would affect unemployment and spending, and people would likely become more cautious, which could mean a decline in GDP growth. Moreover, when the world’s second-largest economy is no longer fuelling global demand, the rest of the world will also feel the pinch. Lower demand for commodities and goods will impact businesses in other countries, which could lead to volatility, uncertainty and a potential global slowdown.
For now, the consensus amongst analysts and market participants is that the collapse of Evergrande wouldn’t have the same scale of global fallout as Lehman Brothers. This is because not only do they hold physical property, unlike Lehman, which held financial assets, but the level of government control in China means there won’t necessarily be a wholesale withdrawal of lending facilities seen during the Financial Crisis. But the possibility of contagion within and outside the country is still a concern, however, the collapse happens.
Even if China steps in to bail out the company, the country is already set on a course of dampening the rampant real estate market, which will have far-reaching implications globally.
“The world economy will feel a bigger impact if Beijing continues its tough campaign to slow growth in the real estate market, hitting consumer sentiment and demand for commodities,” according to Bloomberg. China is the world’s largest consumer of many of the world’s minerals and metals, and a downturn in economic growth there will ripple out well beyond its borders.
A new pandemic of failure?
There are many variables in the Evergrande saga, and any and all of them are causing uncertainty which is affecting global markets. Will the company come to a restructuring agreement with its creditors alone? Will the Chinese government mount a full-scale rescue? Will a state-mandated restructuring take the edge off a corporate collapse? Will the consumer and corporate effect of a collapse spread through the Chinese economy? Will there be contagion beyond the Chinese borders? Is this indicative of an impending slowdown in Chinese growth that will have a ripple effect worldwide?
The crisis in Chinese real estate is another blow to a global economy struggling to make up for the effects of the pandemic. Amidst a return to growth in some parts of the world, setbacks and pressures, from inflation to supply constraints, are increasing uncertainty and causing volatility in the markets.
What can we do?
However the Evergrande crisis is resolved, turbulence and volatility will inevitably affect the markets. Investors looking to hedge against inflation and volatility are turning to the long-term store of value in gold to keep their assets safe by mitigating risk and providing a safe haven during these turbulent times. After the collapse of Lehman Brothers, investors looking to safeguard their assets turned to gold to avoid the turmoil in the markets and the financial system. As a result, the price of gold rose over 8% in 2008, 25% in 2009 and a further 29% in 2010.
Gold has held or increased its value for hundreds of years. However, the vagaries of history show that crises are inevitable, from wars to natural disasters to the complex and interconnected fallout of the global economic system. Throughout these times, gold has continued to thrive and protect investors from the impact of these crises. Anyone recognising the risks inherent in the Evergrande problem would do well to secure their assets with an allocation of gold.