We interrupt Australia’s slow-motion descent into medical fascism to report on a big story from China. Greg Canavan reported on the looming collapse of property developer Evergrande last week. The company has US$300 billion in liabilities. On Thursday, it owes US$83.5 million in interest payments to bondholders on a five-year dollar bond with a yield of 8.25%, according to Bloomberg.
It gets worse though. Evergrande owes US$669 million in coupon payments by the end of this year. US$615 million of those payments are in dollar-denominated bonds. This approaching day of reckoning is why ratings agency Fitch cut the company’s credit rating to junk last month. The Ponzi is up.
For Australian investors, there are two key things to watch in China this week. The first is whether the reorganisation of the company is contained (no contagion). The second is a broader economic question for the Aussie resource industry: when your biggest customer is a serial misallocator of capital, what does that mean for commodity prices?
Chinese junk bond yields spike
We’ll find out the answer to the first question this week. Evergrande is trying to avoid a liquidity crisis that becomes a death spiral. If it has to pay off bondholders and other creditors with cash, it will run out of cash. That’s why, over the weekend, it began offering to pay off investors with discounted properties instead.
It’s a bold strategy!
And if you’re a creditor, you might rather have a vacant Chinese apartment that you can sell (hopefully) in five or 10 years than your cash back. It depends on how badly you need the cash now. Which is hopefully something you thought about before you were tempted by an 8.5% yield on an overleveraged Chinese property developer.
But there is a hierarchy in a company’s capital structure of who gets paid first, especially in the event of a liquidation. Chinese financial regulators don’t want contagion. They can probably live with the highest junk bond yields in a decade — for now. What they can’t live with is an outright default on the company’s bonds that affects Chinese banks, Chinese investors, and Chinese home buyers.
An interesting strategy would be to selectively default to non-Chinese investors and creditors. That’s good domestic politics. But it wouldn’t exactly inspire confidence that China is a safe and well-regulated market for international investors and capital flows.
In the end, Evergrande may be ‘too big to fail’. It’s China’s second-largest property developer (by sales) and the world’s most heavily indebted property developer. Its bonds are distributed across indices all over Asia that track Chinese credit markets. It owns over 1,300 real estate projects in 280 Chinese cities and its property management arm is involved in another 2,800 projects across 310 cities, according to CNBC.
Yet, even if Chinese authorities manage to contain the fallout, prevent default, and placate investors and homeowners, it’s already had an effect on commodity prices and on the share prices of Aussie iron ore miners. How can it fail now?
China has been building ‘ghost cities’ for years; empty apartment buildings that its central planners and developers assure everyone will one day be occupied by fully-employed migrants from the countryside. But did you see last month when 15 high-rise apartment buildings (the Liyang Star City) were demolished in less than 45 seconds by 4.6 tonnes of explosives?
You can watch it here. The development began construction in 2011. Then it ran out of money. The towers have been empty for eight years. Rainfall eventually damaged the integrity of the buildings’ foundations. In order to save Star City, it became necessary to destroy it.
The phrase ‘misallocation’ of resources doesn’t do justice to this kind of material waste. State planning — the kind of which China’s communists are infamous for — means that economic choices are made by central planners rather than individuals. That’s the only way you can waste and malinvest on this scale — when the decisions are being made by others, with other people’s money.
This matters to Australia’s future because China’s economy has been directed by the communists for the last four decades. To promote full employment — and keep people satisfied with the Chinese Communist Party — the real estate and construction industries were allowed to lever up and build out. It consumed resources and generated GDP growth. There was also a boom in housing and real estate prices — which appeared to make everyone wealthy as well.
For years, many China watchers have been expecting the economy to shift from capital-intensive real estate and infrastructure growth to consumer spending — from spending decisions made by central planners to spending decisions made by individuals. We’re still waiting. And if Evergrande is bailed out, we could be waiting for a long time.
Stay tuned to this space to see if there are, in fact, any signs of ‘contagion’. After giving us COVID-19 and turning the world upside down for the last 18 months, is China about to give us a financial flu too? Let’s hope not.
Meanwhile, Little Xi (Dan Andrews) has told Victorians that the real vaccine passport next year will NOT be proof that you’ve been vaccinated but that you’ve received your booster shots. Dictator Dan continues to lead the way in the former free world with his backwards-thinking assault on individual liberty and privacy.
He really is a menace to civil society. The idea that the government can dish out ‘freedoms’ as it likes, depending on your level of compliance with its mandates, is the exact opposite of the Anglo-American tradition. It’s nauseating to see the Aussie press slavishly report on ‘new freedoms’ that are coming (like having a picnic outdoors).
Andrews — and a certain percentage of sycophantic followers in government, media, and elite society — are in the grip of a severe psychosis. They’ve effectively locked themselves in a mental bunker and driven themselves into a dangerous state of hysteria — a hysteria which, to them, justifies draconian and irrational limits on civil liberties.
The good and bad news is that revolutions happen at the margin. They begin with a small cadre of dedicated true believers. These true believers use propaganda and mass media to amplify the impression that their beliefs are widely held and popular. They then demonise the opposition and demoralise the population with their relentless message of subservience.
What’s bad about that is that it often works, mostly because the mass of people are too busy living their lives to take notice or take a stand. What’s good about it is that once you say no to the ‘big lie’ and simply refuse to comply, you find that many others (previously silent) stand with you. That’s how illusions and delusions collapse.
In the end, Australians are too sensible to not see what’s happening. Vaccine mandates, vaccine passports, and a two-tier society of the ‘vaxxed’ and the ‘unvaxxed’ are a much greater risk to the country than the virus itself. The tide is turning Australia. That’s the good news.
Until next week,
Editor, The Rum Rebellion
PS: Attentive readers will note that the same kind of wasteful central planning that’s on display in China (and failing so miserably with destroyed buildings) is at the heart of the Andrews government response to a virus. It’s a combination of hubris and ignorance that government planners can contain a force of nature and redirect the direction of society. The virus has become endemic — not something that can be fully eliminated but which we will have to live with forever. In the end, it will destroy the pretensions of tinpot dictators like Dan Andrews.
The Bonner-Denning Letter is co-authored by Port Phillip Publishing founder Dan Denning and legendary investment writer and publisher Bill Bonner. It connects the dots between markets, politics, and history as one of the only macroeconomic, ‘top-down’ newsletters in Australia. For a big picture perspective on the past, the present, and your investment future, click here for details on how to subscribe.