Imagine if tomorrow, the Federal Reserve announced that the top ten home builders in the United States are insolvent. They would cease paying interest on debt and probably would default on principal payments. Further, their bonds would be frozen for some period as the Fed sorted through their finances. It is not too hard to imagine as 13 years ago something close happened when Lehmen Brothers collapsed. It started a long financial panic and then a long recession.
Something similar is now happening in China. The nation’s largest developer is no longer able to pay its creditors. The Chinese government announced yesterday that the firm will not make interest payments and probably will default on principal payments, although that remains unclear. China Evergrande has liabilities over $300 billion, but this is China, so no one knows the real number. All anyone knows is they sit at the heart of the Chinese financial and real estate system.
One thing that is universally true in all times and all places, even in China, is that real estate is the base asset. Mother Nature is not making more of it, so it remains a constant and therefore the basis of all value. It is why this development is not just another story of corrupt financial dealings. As in the West, all land in China is leveraged and that leverage is treated as an asset, which means it is leveraged. If Evergrande stops paying its bill, many other firms stop paying their bills.
At this point, the financial world is not all that concerned with what is happening in Chinese real estate, but they were not concerned about the mortgage crisis in the United States until it was a pending disaster. The old claim that financial markets look forward and therefore offer a glimpse of the future was always nonsense, but the Lehman disaster proved that markets are not the future. The world of finance assumes tomorrow will be yesterday but better.
At the minimum, the Evergrande crisis is a test of the new Chinese model of governance ushered in under Xi Jinping. The relatively loose days of Chinese capitalism are coming to a close as the party imposes new rules on the economy and cracks down on its pirates. The focus is now on domestic growth, rather than cheap labor and exports. China is no longer the cheapest or most productive labor market in the world, so it cannot remain an export economy.
No one really knows if China can successfully make the turn from export economy to one driven by domestic consumption. The breathtaking modernization of the country is impressive, but that required massive cooperation from the West. If the United States had a ruling class concerned with the welfare of the American people, for example, the Chinese miracle never would have occurred. The feckless American ruling class cannot help China transition to a domestic demand driven economy.
The bigger question with regards to China and this current financial crisis is can the Western financial model survive the Chinese transition. For the last thirty years the corrupt Western ruling class has preserved itself like all corrupt ruling classes have done and that is with bread and circuses. The Chinese economic miracle has kept inflation down and money printing up. Cheap goods from China have been an essential part of maintaining stability in the West.
Inflation is already becoming a problem in America. In most parts of the economy, the food markets are plagued with supply chain problems and rising prices. Then there are labor market problems, some of which were created by the Covid panic, but others are the result of demographics. Those Baby Boomers taking early retirement due to the Covid panic are not going to be replaced by the magical people that we see on television shows and commercials.
Of course, the great retirement boom that is just started in the US will put massive strain on programs like Social Security and Medicare. Those programs represent trillions in debt that can never be paid in current dollars. Medicare is now projected to run out of cash in ten years. Social Security has been insolvent for a long time now, based on generally accepted accounting practices. Its assets were spent years ago by the government, leaving it with worthless IOU’s.
People are pointing to the current crisis in China as a replay of the Lehman debacle 13 years ago, but in reality, it is a continuation of it. Starting in the 1980’s, the people actually in charge of the world began to transition the global economy away from an asset based system to a credit based system. The great debt explosion that ensued took many forms and the rise of China was one aspect. Without the massive growth in global debt, China’s growth would have been impossible.
The thing with debt is that it has to eventually be repaid. That means there is a hard limit to the amount of debt that can be generated. A system based on the assumption that debt can expand forever will naturally end in a crisis when that that assumption runs into the reality of the debt limit. In this regard, Lehman, the mortgage crisis and now the Evergrande crisis should be seen as warning tremors. One day soon there will be no way to paper over one of these crises.
Step back and look at what has happened over the last half century and what you see is an effort to mitigate the demographic decline of the West. The reason China was so attractive to the West is she was full of young people. China’s utility to the West is in decline because she is rapidly getting old. The massively complex system that is the Western financial modern is just a way to turn the youth of other societies into cash for the Western welfare state. Their vigor is our safety net.
The trouble is the system drains the vitality of all those exposed to it. Japan was the first example of a formerly fecund society drained of its youth and vitality by exposure to the Western economic model. Korea soon followed. Now we see all of the same signs in China as she nears the end of her economic cycle. The only place left with lots of young people is Africa, but even the scheming of Western elites will never be enough to conquer the dark continent in this way.
In this context, what is happening in China is a sign that the system of endless credit expansion is really the implementation of a system that converts civilizational vigor into cash for a tiny minority. The natural limit on the expansion of credit is set by the limit of young people available to be consumed. China’s future was written in her one child policy and ultimately that would set the end times for the West. Once we run out of kids to convert to credit, the plates stop spinning.
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