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Investors soured on stocks in Europe and the U.S. as the week began. The proximate cause of the sell-off was concern over Evergrande. In truth, the company has been a source of concern for many China skeptics for years as it borrowed oceans of funds to build itself up into a goliath with $355 billion or so of assets. But for years it was assumed that the Chinese regime would not let Evergrande fail, so the risks of its debt-heavy structure were ignored by all but a few short-sellers.
No more. Investors over the weekend went from worrying about whether Evergrande would default, to worrying about what other developers might be next, to worrying about knock-on effects on creditors who might be over-exposed to Evergrande, to speculating that it might be too late to avoid a systemic crisis.
Part of the Evergrande problem is the broader weakness of the Chinese recovery. That weakness, which recently saw Bank of America drop its growth expectation for next year from 6.3 percent to 5.3 percent, stems from two root causes. The first is simply a tight fiscal and monetary policy, as the Chinese government continues to try to squeeze speculation in real estate and reduce what it viewed as excessive risk-taking by lenders.
The second is, in many ways, more profound: Xi Jinping has made it clear that he is bent on fundamentally restructuring the Chinese economy. Instead of moving closer to something like Western-style capitalism, Xi wants China to return to something like Mao's socialist vision. Mao saw capitalism as a phase on the road to socialism, and Xi has decided it is time to move on down that road.
What this means for a giant company built on real estate speculation and debt as it teeters on the edge of default is far from clear. Surely, Xi wants its Chinese creditors, vendors, and some 200,000 workers protected. But what about outside creditors from the West? James Carville famously said that if he was reincarnated, he would want to come back as the bond market because the bond market can intimidate anyone. In Xi, perhaps the bond market has met its match.
– Alex Marlow & John Carney
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