The crisis of the Chinese real estate giant Evergrande implies something much more serious than the simple collapse of a real estate company. As the crisis deepens, it is becoming clear that what is really crumbling is an entire real estate system based on economic speculation and not on real needs, which could affect the entire productive system of the Chinese regime and even the capitalist world.
Evergrande, the world’s most indebted real estate developer, is currently struggling to repay more than 300 billion dollars in liabilities, which include almost 20 billion in international market bonds that rating firms considered cross default last December after the first maturities.
In the face of repeated defaults, the Chinese communist regime has intervened on several occasions to prevent a disorderly collapse of the business group in order to minimize the consequences—which may affect the rest of the economy—as much as possible, reported CNN.
Although Evergrande is on the front pages of all the media for being the largest real estate development company, the reality shows that all the firms in China belonging to this area are in a similar or worse situation, which shows that the crisis does not exclusively belong to private factors but to deep structural issues of the economy led by the Chinese communist regime.
Fitch Ratings, the international credit rating agency, recently published a report in which it states that if the exponential trend in the fall of real estate sales in China continues, at least one third of the development companies rated by them will suffer an inevitable financial deficit in the coming months.
The collapse of Evergrande and the real estate market in general affects not only the company and its thousands of employees but the entire Asian country. According to recent reports, China has more than 30 million unsold houses at the moment, resulting in hundreds of “ghost cities” completely in debt and with no horizon of how to get out of the abyss.
Local governments cannot afford the costs of the growth of their own cities and as a result, Dantesque scenarios arise as a result of lack of maintenance, abandonment, lack of jobs and the consequent lack of movement of people.
Source of the conflict
The financial and real estate markets under China’s communist regime have been on shaky ground since the Evergrande crisis grabbed global headlines over the past few months. The result is that now China’s real estate market has become a huge bubble waiting to burst.
To understand what has been happening and how the Chinese real estate market reached this point of collapse, it is necessary to define certain concepts such as “real estate bubble”.
What does the development of a real estate bubble imply, and why can it cause a crisis to burst? These questions must be answered to move forward with the analysis of the complex situation of the Chinese economy.
This phenomenon arises when the market reflects the explosive increase in the price of real estate due to high demand and low supply. In this situation, financial speculators inject more money into the market, causing a further increase in demand.
Then, at a certain point, peak demand begins to fall, while supply continues to increase. When that happens, the bubble bursts. And this is exactly what is happening today in China.
In short, the bubble in the communist regime’s real estate market has led to a steady rise in property prices, and construction companies took advantage of the situation and rushed to build more houses and buildings without noticing that demand was falling at an outrageous rate.
Role of the Chinese regime in the real estate crisis
As in everything that happens within the communist country, the government has a very active participation and is ultimately the one who determines the course of how, when and what should be done in all economic activity.
The real estate market is no exception; in fact, it was the business chosen by the regime as its engine of economic growth during the last decades.
Real estate and related sectors are one of the key drivers of the Chinese economy, accounting for more than 30% of total GDP. The proportion of economic output related to construction and associated activities is much higher than in all other major economies, notes renowned economist Mark Williams according to CNN Business.
While it is undeniable that this activity, largely encouraged by the regime, has managed to activate the economy remarkably and was the mainstay of steady growth, critics always warned that this engine was not genuinely working, and was simply creating a real time bomb due to the huge debt being generated by developers.
However, the Chinese communist regime turned a deaf ear to the recommendations of experts and continued along the same path. Today the results are beginning to show and the danger of a total financial collapse is imminent, which could affect not only the Chinese economy but the entire world.
“Ghost Towns”: Symptom of a crisis foretold
For some years now, the term “ghost cities” has been used in real estate jargon.
Historically, this term brings to mind the image of urban conglomerates formerly abandoned due to some kind of natural catastrophe that may have caused their citizens to flee, leaving the city in ruins and deserted, generating a gloomy scenario.
However, the term we are referring to here and the one we have been hearing in the real estate market environment has nothing to do with that reality.
These cities are composed of new and huge concrete constructions, generally with a modern look, large public spaces, wide roads, bridges and structures to support the conglomeration of thousands or even millions of people daily. The curious thing is that these “brand new” cities are practically empty.
Technically these ghost cities were not abandoned, but never occupied. China currently has at least 65 million empty homes, many without owners and many others unoccupied and trying to be sold or rented by their owners. The sum of these homes is enough to house the entire population of France, Business Insider magazine reported in October 2021.
One of China’s best-known ghost towns is Ordos New Town, also called Kangbashi, in the Inner Mongolia region.
In the early 2000s, the town was intended to house one million people, a number that was later reduced to 300,000. It was inaugurated in 2003 by the Chinese Communist regime, touting it as the result of years of progress and growth. However, in 2016 barely 100,000 people lived there.
Another of these particular cities is called Tianducheng, known as the Paris of China, about two hours west of Shanghai, was supposed to look like a miniature Paris because of its type of architecture, cobblestone streets, Renaissance fountains and the construction of a 300-foot (91-meter) tall Eiffel tower that can be seen from almost any point in the city.
Originally intended for a population of 10,000 inhabitants, today, however, the city does not exceed 10 percent of what was planned.
Kangbashi and Tianducheng are just a couple of examples of the many cities of this style in communist China, which reflect the enormous contradictions that prevail under the oppressive system. On the one hand, millions of poor inhabitants living in appalling conditions in rural areas and on the other hand, luxurious cities practically empty as a result of artificial growth based on speculation and not on the natural law of supply and demand.
How did it come to this point?
A couple of questions should be highlighted in order to understand this strange phenomenon of “ghost cities”.
In the first place, given how difficult it is to invest in private businesses in China due to the controls imposed by the communist apparatus, those sectors that benefited the most and were able to generate some type of savings used real estate as a “safe” investment, buying houses and apartments only to resell them directly and obtain a difference.
Another point to consider is that, as mentioned above, the progressive increase in real estate prices made it tempting to buy properties to resell them when the price would be higher in the near future.
For this purpose, private individuals promoted the construction of real estate, but mainly large real estate firms began to take on debt both inside and outside China, to build huge buildings, roads and entire cities, speculating that prices would continue to rise and at some point they would be able to sell, pay off debts and make a profit.
This fictitious situation was very functional for both the real estate firms and the communist regime, which was enriched by the sale of land, while at the same time increasing employment levels in the construction sector. On the other hand, local and international lenders and investors also benefited from the high rates of return.
Everything went smoothly until the lack of demand for properties started to become more and more noticeable and consequently prices started to trend downwards. The suspension of real estate sales led the firms to stop receiving income, and consequently there was a cut in the chain of payments, logically affecting the whole market and revealing so many years of business based on the artificiality of speculation.
What did we have as a final result? Millions of citizens left with unused properties that they cannot sell for profit because there are no existing buyers, and indebted real estate companies, Evergrande as the ultimate benchmark, with gigantic construction projects that are often technically useless.
The Evergrande Case
Evergrande Group, one of the two largest real estate developers in the history of China, founded in 1996 in the city of Guangzhou, became in a few years one of the largest companies in the world due to its enormous revenues.
It directly employs some 200,000 people and indirectly promotes 3.8 million jobs every year. Parallel to the real estate business, Evergrande also invested in electric vehicles and sports and theme parks. It also produces and markets food and beverages, such as bottled water, groceries, dairy products and other goods throughout China.
In 2010, the company bought a soccer team, which is known as Guangzhou Evergrande, and since then, the team has built what is believed to be the world’s largest soccer school, at a cost of USD 185 million to Evergrande.
Xu Jiayin, a Chinese-born billionaire, was the founder of the group, and was once considered the wealthiest man in China.
In recent years, to finance huge projects, the powerful firm had to take on huge debts in both the local and international financial markets, speculating that it could pay them off with revenues from the profitable, albeit fictitious, real estate business.
As promising as many of its projects looked, Evergrande warned in 2021 that it would not be able to meet the maturities of a huge debt assumed due to its lack of liquidity.
Reportedly, in China alone, Evergrande owes money to some 171 domestic banks and 121 financial firms, its total liabilities being around US$300 million.
This situation presents an extremely complex scenario for the Chinese communist regime. If it allows the company to go bankrupt and not meet its commitments, the financial consequences could be very serious for many sectors of the Chinese economy. But the reality indicates that there are many other firms in the industry in similar conditions, which could also demand a bailout from the state if the regime decides to continue with its bailout policy, which could lead to an unstoppable wheel.
In mid-January 2022, Evergrande presented a debt restructuring plan in an attempt to reassure the markets. But in practice it ended up generating the opposite effect. Investors expressed skepticism about the real estate giant’s “lackluster plan” and as a result saw a sharp drop in shares, Reuters reported.
China Evergrande executives told creditors in a call late on Wednesday that the company hopes to work with them to reach a risk management solution. The company added that it would treat all categories of creditors “fairly and following international practice,” while urging them not to take any “aggressive legal action.”
The company’s communication with creditors comes at a time when Chinese authorities are tightening control over the real estate developer and taking measures to stabilize the indebted sector.
Meanwhile, the US Federal Reserve announced on Wednesday that it is likely to raise interest rates in March. This situation, if confirmed, will put further pressure on the ability of Chinese real estate companies to continue financing in the United States.
Conclusions and future prospects
Given this complex scenario, there are more doubts than certainties about the future of both the Chinese real estate market and the possible effects of the crisis on the rest of the Asian and world economy.
Although it is difficult to predict the future, it seems to be a little easier to find the origin of the problems, and if it is a question of finding those responsible, the Chinese communist regime is the main defendant.
At some point both Evergrande and the rest of the real estate developers fell victim to Beijing’s changing approach to managing China’s gigantic economy over the past few decades.
Shortly after coming to power in 2013, President Xi Jinping said that China needed to “change the approach to improve the quality and returns of economic growth…to pursue genuine rather than inflated GDP growth”, this implies that the government was fully aware of the bombshell that was brewing.
However, Xi Jinping’s words never came true, and the speculative system continued to develop until it reached the edge of the abyss.
Today it is too late to plan how to develop the economy and avoid the crisis. The Chinese regime has only to decide what role to play in the chaos, which implies a great dilemma. If it intervenes to rescue Evergrande, what message will it send to other heavily indebted developers? But if it does not help, what will be the consequences for the rest of the economy?
Many analysts assume that Beijing is already taking a leadership role in guiding Evergrande through a restructuring of its debt and expanding business operations, although many experts doubt whether that role is being played responsibly or is simply another “stopgap” to ride out the moment and then continue with speculative and fictitious policies.
“China’s leadership is trying to play it cool, but the circumstances surrounding Evergrande’s downward spiral raise serious questions about (Chinese President) Xi Jinping’s management of China’s rapidly cooling economy,” said Craig Singleton, deputy fellow in the China Program at the Foundation for Defense of Democracies, a Washington DC-based research institute.
For its part, the local government in Guangdong province, where Evergrande is based, said late last week that it would send officials to the company to oversee risk management, strengthen internal controls and maintain normal operations.
If it is difficult to know what the consequences will be in China, it is even more difficult to make predictions about the impact on the global economy.
Just as no one really foresaw the implications of the collapse of Lehman Brothers more than a decade ago, which ended up generating a huge recession first in the United States and then affecting the entire world, it is not possible to define with any certainty what will happen in this new and complex scenario.
In order to know how the events will unfold, we will have to wait to see whether large indebted firms such as Evergrande continue to default on their debts in the coming months, and also what role the Chinese communist regime will finally play in this eminent financial collapse.