Evergrande default: Climbing the wall of Chinese worry (as usual)

George Kessarios
Chief Economist & Fund Manager

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Evergrande default: Climbing the wall of Chinese worry (as usual)

Finally, we have headline scares out of China. Earlier this week markets were spooked about the possible default of the world’s most indebted developer, which is none other China’s Evergrande Group.

Usually, what happens in China stays in China and has no consequences outside of China. This because China is mostly a closed economy and very rarely anything that happens affects anyone else. Except for exporting a little deflation, which is mostly a good thing.

And given that there will probably be a domestic policy response from the Chinese government (as everyone thinks), any implications within China will also probably be limited.

For some strange reason what applies in western economies does not apply to China. The housing bubble in China has been ongoing for many years now, with analysts and economists forecasting a crash, but no crash ever occurred. Even Hong Kong’s real estate market has been an ongoing bubble for the past 20 years or so, but still no crash.

Yet it is terrifying when one looks at just how expensive real estate in China is, and the implications of a possible nonorderly Evergrande default.

The chart below comes from Nordea and depicts housing affordability in China.

The latest data show that the ratio of the median house price to income in Beijing is about 25, about 13 in all of China, and about 21 for Hong Kong. During the US housing bubble in 2008 this ratio was about 7-8.

So, while everyone expects the Chinese government to mediate and somehow solve the problem, one must ask themselves if it is different this time? Especially if government mediation does not happen or, does not happen enough.

The entire construction sector, including commodities like iron, copper, and cement will be impacted. Many products and services that go into construction, like elevators, will also be hit. Consumer behavior will also be impacted as well. And while local banking issues could be managed, and will have no global impact, Chinese consumer behavior will. The consumer in China is simply too big to be ignored, even by many US companies.

So, getting back to the question if an Evergrande default can have global spillover effects, the answer is probably yes, if the unwinding is not orderly. But even with no spillover, the wall of worry of the Chinese housing bubble will continue to be with us.

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