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Evergrande Deep Dive: A True Threat To Crypto Or Just FUD?
We could be headed for another Lehman brothers scenario. An uncontrolled default of the Evergrande group could lead to a credit crunch the likes we haven’t seen before. In fact, it could have dire implications for all financial markets, especially crypto. Therefore, if you want to know what the hell is happening and what it could mean for your portfolio, stick around and read on. We’ve got some work to do.
I’ve written before how crypto is like the wild west, and I hold to that. However, like the wild west, which had a few good people to try and keep the peace, I’m going to try and give you as much information as I can about the whole Evergrande situation, so you can arm yourself with the knowledge to fight and protect you and yours. Also, understand that while I know a thing or two, I’m not a professional financial advisor.
Now, we are going deep in the weeds on this one because it’s that important. Therefore, if you’re pressed for time like most people, I’ve broken this piece down into subsections so you can skim to the spot that concerns you the most. Yet, I do recommend reading the whole newsletter, so it’ll connect some dots you might be missing. But, I leave it up to your good offices to decide.
If you’re ready, start where you want to, and let’s get it.
The Chinese property bubble
We can’t talk about Evergrande without first talking about the Chinese property bubble. This is because it has allowed Evergrande to become so systemic in the first place. To say the Chinese property market is in a bubble is an understatement. It’s been so hot recently that off-plan units sell out online in minutes. For example, in March of last year, 288 units in a new property development in Shenzhen sold out in less than eight minutes, The Wall Street Journal reports. People are putting down up to $100,000, so real estate holders will consider them for buying properties two to three years from now.
One of the main reasons the Chinese property market has been exploding at such a pace is because people see property as one of the primary forms of investment in the country. Compared to their western counterparts, Chinese citizens own more property than they own bonds or stock in a report by Seeking Alpha.
Furthermore, according to YiCai Global, as of late 2020, 96% of China’s urban households owned at least one home. However, in the U.S., the number is closer to 65%. Unfortunately, China’s housing bubble might eclipse that of the U.S. in 2009. For example, at the peak of America’s property boom, individuals and institutions invested $900 billion per year in residential real estate. In contrast, Chinese citizens and corporations invest $1.4 trillion per year.
Yet, in recent years, buying Chinese property has been more about speculation than investing. Chinese citizens have been buying more in the belief that property prices will continually go up. After all, that’s what real estate does. It goes up, never down (hmm).
Whatever the case, the Chinese bubble continues to grow. Even through the United States’ 2009 housing crisis, which had a global impact, China’s property market lost no steam. And, as you can probably guess, people aren’t making these purchases with any savings. Instead, Chinese citizens and companies are taking on massive debt to buy property. It’s a mirror image of the 2009 debacle, except that somehow the picture is enormous. Oh, and China household debt accounted for 62% of the $11.6 trillion increase in borrowing from 2007–2021, in a report by CEIC.
Additionally, it’s dangerous that we’re looking at a debt-fueled property bubble and that it’s leading to massive increases in the cost of living. For example, in Tianjin, apartments in ritzy areas go for $836 per square foot. That compares to some of the wealthiest parts of London, England. However, disposable incomes in London are seven times higher than those of Tianjin.
The property boom hasn’t escaped the gaze of the CCP either, and they have become increasingly concerned over the situation. For example, President Xi said, “Housing should be for livingin, not for speculation,” in a 2017 Bloomberg article. However, the Chinese government finds itself in a catch-22 situation. With so many citizen’s worths tied up in housing, if the government were to try and deflate the bubble, it could lead to social unrest. And when you’re a one-party state, that’s not something you want — nor does anyone. So, the CCP will gladly let the housing market grow as long as it keeps the populace happy. However, when the ingredients that first started the bubble are no longer there, you get a crash of terrible proportions.
Still, before we look at what that crash could look like, we need to dive into Evergrande. The star of this particular horror show.
The Evergrande saga
Evergrande is one of the largest property developers in China. Hui Ka Yan founded the company in 1996 in Guangzhou, and it has grown like wildfire ever since its inception. As a testament to that fact, Yan was at one time the wealthiest man in China as he steered the company through the property boom. In addition, when the company launched its IPO in 2009, it raised over $1 billion. To further emphasize the size of Evergrande, it heads over 1,300 projects across 280 countries globally.
Furthermore, the company employs over 200,000 people, and if you include contracted and sub-contracted labor, that total increases to 3.8 million. That makes them one of the largest employers in China today. Yet, Evergrande wanted to deal in more than property. It strived to diversify its business sectors of influence. So, in some cases, they delved into markets further from their core competency than they could be. I.e., automobiles, food, and dairy products. To reach even further, the company bought a soccer team and built a soccer school. They even had plans to build a $1.7 billion soccer stadium for the team to play.
And yet, those aren’t the craziest examples of Evergrandes ventures. Museums, health parks, and a fitness chain were all on the table. Finally, they explored the market of offering financial products to clients. Now, all of that is fine. Honestly, many companies diversify their interests to maintain stability, flexibility, and dynamic growth. The problem is that Evergrande, much like the typical Chinese household, didn’t fund their purchases with liquidity or reserves but with debt. According to Bloomberg, they are $300 billion in debt, with some banks freezing Evergrande deposits in case the worst happens sooner rather than later. And if you’re keeping up on current events, it looks like sooner. So, how did they manage to get into this mess?
In its rapid expansion over the past few years, Evergrande has taken on many forms of debt. These include bonds, bank loans, and international dollar bonds. However, one of the most common forms of debt the company has taken on is commercial paper. As a brief refresher, commercial paper is an unsecured form of promissory note such as IOUs and other payables. It’s an interest-bearing note typically issued by large banks or corporations to meet short-term financial obligations. In the case of Evergrande, commercial paper was the form of payment given to contractors and suppliers who worked on their projects. Consider them Evergrande dollars (E.D.) or script. Generally, anyone working with the company saw E.D.s as secure. So much so, those same suppliers and contractors used E.D.s to pay other vendors for services they used. Are you worried yet? Bloomberg was and posted an article revealing Evergrande’s $32 billion worth of IOUs citing liquidity concerns.
But let’s not stop there. Evergrande has outstanding loans with multiple banks in the billions. In fact, last year, the company reported total loans and other borrowings at $107 billion. Okay, that’s a whole lot of Bs there. But the company is enormous, and they can pay it back, right? That’s a hard no. The debt-stricken company has seen declining profits over the two years. You can see how steep it is from this tweet. In summation, Evergrande is the most indebted company in China. As you will see further into the above tweet, the company can no longer pay the interest on its current debt, not to mention the principle. They are, financially, in the same boat as the United States, with one exception. Evergrande released a statement a few months ago that they may not see a way to service their debt and thus, could look to defaulting.
Furthermore, S&P has downgraded them from CCC to CC with a negative outlook as default looms. Finally, Evergrandes shares are down over 80% so far this year. However, those aren’t some of the worst parts of this perfect storm. Evergrande has taken deposits on homes that haven’t been built yet from over 1.5 million Chinese citizens. That’s a lot of heartbreak ready to happen.
Now, you may be thinking, “hey, if the company is so important and the CCP is the type of government that integrates with companies allegedly more than in America. Why don’t they bail them out like we do?” Well, the Chinese government has taken a hard line against leverage in the property sector. A few years ago, it came out with directives to limit debt, and companies know them as the “three red lines.”
Cash on hand
Value of assets
Value of equity
Evergrande has broken all three, and the CCP doesn’t want to create a moral hazard as the U.S. did in 2009. Therefore, they are willing to allow the company to fail as an example to other companies who want to make decisions based on speculation instead of real-world assets, cash, and equity. So, it’s not a question of if Evergrande is going to default but when. And, of course, a country can’t contain something this big, so it’ll spill over into the global economy.
There is a real risk a crisis of this magnitude will spill over into global credit markets. Once again, it’s akin to precisely what happened in the U.S. in 2009. Let’s start with the counterparties involved. “Evergrande’s liabilities include more than 128 banks and 121 non-banking institutions according to a letter it sent to the chinese government late last year,” Reuters reports. Let’s also not forget how much E.D. is out there in the market. Businesses and people have used Evergrande’s commercial paper like it was good as gold. And we have no idea how many times E.D.s have changed hands, but no one was worried about it. After all, how could a company so big fail? Yet, failure is almost inevitable, and with Evergrande’s connections to so many individuals and institutions, not only in China but abroad, their default would ripple outward beyond the borders of their homeland. Again, the banks with ties to Evergrande deal in their bonds, commercial paper, and equities. By design, they must be affected.
Even in the best-case scenario where Evergrande tries to reconcile its debt, it would take a significant selling off of assets. And remember, most of the company’s assets are in its properties. If they were to have a fire sale on all of their properties, it would send property developers and Chinese citizens who bet on the market into heavy negative territory. Also, don’t forget the 1.5 million people who’ve deposited money with them in hopes of acquiring property someday. All of the harmful activity will send collateral backing debt tumbling, which will make everyone more indebted. And that ripple? It will hit all financial sectors, finally bringing us to the crypto market.
Impact on crypto
As we’ve seen from the past year, the crypto markets aren’t entirely insulated from traditional market forces both at home and globally. For example, during market stress, Bitcoin acts more like a risk-on than a safe haven. And you can see that example in this article by CNN. We also saw this play out during last year’s coronavirus crash. In fact, we could be looking at a significant selloff of Bitcoin assets from individuals and institutions alike when Evergrande defaults. I know you’re thinking, “T.C., China doesn’t allow anyone to hold crypto anymore.” And I wouldn’t fault you for that. However, they didn’t fully succeed in the purge, as cited by this article from CNBC. Many people still hold significant influence in crypto markets there.
In short, global macroeconomic forces impact crypto in the short term like any other asset. However, one other factor unique to crypto could be lurking beneath the surface of this madness. I’ll give you a hint. It starts with a “T,” and there’s about $68 billion of it.
You know it; I know it; everybody knows it. It’s Tether. The cryptocurrency “stable”-coin that can’t catch a break. On top of all the potential incoming regulations to crypto, there are concerns that Tether could be exposed to Evergrande. These suspicions arose from information that Tether hoped would temper FUD and not fuel it. That is the attestation report issued several months ago by More Cayman. In it, Tether’s commercial paper and certificates of deposit total over $30 billion backing its coin USDT. In fact, before Evergrande posed a threat to global markets, people applauded Tether’s transparency and line item reports on where its backing lay. Now, with the emergence of Evergrande’s turmoil, so too has turmoil emerged for Tether. And on top of that, another question looms: why does Tether have over 50% of its reserves in commercial paper and certificates? There are two possibilities:
1. It wishes to earn interest on those paper reserves.
2. There are no banks keen on the idea of holding $30 billion worth of cash or equities for Tether.
So, after all that, one last question remains: is any of the $30 billion in paper Tether holds in reserve, Evergrande paper? The truth is, it’s uncertain, and that’s part of the problem. The mere hint that there’s a possibility that any of Tether’s paper reserves are Evergrande can send speculation shockwaves through the markets to disastrous effect. The implication is that Tether isn’t fully backed reserves as it states.
Furthermore, if any of that paper is Evergrande and they default, it becomes less valuable. And that puts Tether in yet another sticky situation. So, why does this matter for the crypto markets?
Because Tether remains one of the most crucial components for Bitcoin liquidity, it is the crypto coin pairing of choice on many off-shore exchanges. For example, take a look at the 24hr trading over at CoinMarketCap. Tether traded nearly $79 billion, and the next nearest stablecoin, Binance USD, traded at almost $6 billion. That shows the insane confidence in Tether from markets and investors. Therefore, if there arises a confidence issue with Tether, it could create a liquidity crisis within crypto, rippling through all its coin pairings. Yet, we still don’t know for sure the extent, if any, of ties between Evergrande and Tether. So, here’s hoping that there’s a definitive answer to this question and any concerns are put to bed.
Whether or not all this happens depends on the Chinese government coming to the aid of Evergrande.
We’ll see what their move, if any, does to the markets. And how it will affect the mindset of other Chinese businesses. Is it now okay to do business irresponsibly, knowing the government will bail you out? Furthermore, while it could create a short-term fix, the disease of Evergrande’s massive and intricate debt lingers, and a bailout might not solve their problem completely. All said vigilance is vital to survive what’s coming.
We’ve looked at how Evergrande can impact crypto, including everything that leads us to where we are now. The Chinese property bubble, Evergrande’s debt-based spending, and their potential effect on global markets and Tether could significantly impact the cryptocurrency market in the short term. However, I remain bullish on the long-term for crypto. While we know traditional market forces influence crypto, we’ve also seen crypto, in this specific case, Bitcoin, provide some stability for uncertain times like the 18% Nigerian inflation hike.
In conclusion, read, educate, stay informed.
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