This is a huge risk to the Australian economy by 2022 and this financial catastrophe shows no signs of ending.
As we move towards the conclusion of a difficult 2021, Australia’s economy is radically different from what it was when we entered the pandemic.
Key industries such as tourism and education have been supplanted by even higher levels of resource exports, leaving Australia more dependent than ever on China.
In recent weeks, Treasurer Josh Frydenberg has warned that the Chinese real estate market poses a risk to the global economy and that he is monitoring the sector closely.
With the building construction sector and related industries accounting for about 30 percent of all economic activity in China, the treasurer has reason to be concerned.
The Evergrande factor
Over the past few months, Chinese mega real estate developer Evergrande has become a household name to many, as his woes have sounded alarm bells for markets and governments around the world.
To put Evergrande’s immense size into perspective, if the estimated developers of on-balance-sheet and off-balance sheet bonds are all counted, this is more than the outstanding Australian federal government debt before the pandemic.
In early December, Evergrande officially defaulted on its debts and began what promises to be an extremely long restructuring process.
While the concrete and publicly known liability of Evergrande is immense, amounting to over $ 300 billion, arguably the biggest threats come from what goes on behind the scenes.
Shadow banking – the Chinese financial underworld
In China, when a company cannot obtain traditional financing from a bank or the bond market, it can turn to shadow banking to raise capital.
It can take different forms, but suffice it to say that the scale of this obscure form of finance in China is immense. For example, in September, Goldman Sachs estimated that Evergrande alone had about 1,000 billion yuan (about A $ 220 billion) in off-balance sheet and contingent liabilities.
How much hidden and / or off-balance sheet debt is actually held by companies in the Chinese real estate sector and those related to it remains a mystery, but one would imagine the figure to be immense.
The risks of an iron fist approach
Unlike much of the Western world where even some of the largest and most damaging business failures often go unpunished, in China the consequences of this type of failure can be immense and in some cases fatal.
While the merits of this approach compared to the sometimes apathetic response from Western magistrates and policymakers remain a source of debate, there are very clear downsides.
This brings us to an unlikely historical analogy that comes from ancient China.
In 209 BC, two Qin Dynasty army officers, Chen Sheng and Wu Guang, were late due to flooding resulting from a severe rainstorm. Under the laws of the ruling dynasty, Chen and Wu would be executed for not arriving on time, although this was completely beyond their control.
Rather than attempting to argue extenuating circumstances and running the high risk of being executed, Chen and Wu instead decided they had nothing to lose and started an uprising against the crown.
After years of President Xi and the leadership of the Communist Party of China condemned questionable transactions and insisted they wanted to avoid systemic risk, parties to shady deals have little incentive to raise potential issues unless they absolutely have to.
Like Chen and Wu over 2,200 years ago, taking a hard line can cause individuals to take a course that is against the interests of the Chinese government.
A mountain of strangers
Between President Xi’s goal of reducing systemic risk by reigning in the real estate industry and pushing elements of the shadow banking industry to mask the impact of bad debt, problems may loom over a long period of time. before rising to the surface.
The truth is that hardly anyone fully understands the true extent of off-balance sheet liabilities and the extent of the links between China’s shadow banking sector and the more formal parts of the financial system.
Then there is the damage that occurs to China’s real estate industry every day that the CCP’s crackdown continues.
With real estate in China increasingly being treated as a speculative investment rather than a house, the impact of the Evergrande saga on confidence came quickly.
In most major Chinese cities, prices for new and existing real estate are falling for the first time since 2015.
At the same time, local governments have become increasingly dependent on the efficient purchase of land made available by themselves in order to maintain a constant flow of income.
Australia, the year ahead and Chinese real estate
Treasurer Josh Frydenberg is not the only one worried about the potential problems that could arise from the woes of the Chinese real estate sector.
In October, US Secretary of State Antony Blinken warned that the fall of Evergrande could affect “literally the whole world” and that China should act “responsibly” in handling the current crisis.
Many around the world are waiting to see what happens next in Evergrande’s story, as the fate of the global economic recovery from the pandemic potentially hangs in the balance.
Predicting what’s going on from here is difficult to say the least, but there are some things we know with a reasonable degree of certainty.
The Evergrande saga is likely to drag on for months or even years to come, and Chinese President Xi Jinping will continue to seek to reduce systemic risk in order to ensure a stable China.
Beyond that, we can only speculate on the fate of China’s real estate industry and everything from a crisis-induced recession to a commodity price boom is a potential scenario on the table.
Tarric Brooker is a freelance journalist and social commentator | @AvidCommenter