As Chinese property behemoth Evergrande tumbles toward a financial precipice, financial institutions around the world are falling all over themselves to assure us that their exposure to a teetering Chinese real estate market is minimal, that this isn’t about to snowball into a global problem.
Which, history cautions, is a pretty good time to start to worry. Massive financial failures have a way of snowballing. This probably is a global problem.
How big a problem is hard to predict, much less measure. But you don’t need a particularly long memory to recognize how a major failure in an opaque corner of the financial market can send serious ripples that spread far wider in the global economy than any analysis of “direct exposure” to said failure would suggest.
Past experience – in the global financial crisis of 2007-2009, in the Asian currency crisis of 1997-1998 – has taught us the hard way that we often don’t appreciate how interconnected the world’s finances are until it’s too late.
The general consensus of experts at this stage – that Evergrande’s debt problems can largely be contained within China – may still prove correct. The vast majority of the company’s more than US$300-billion mountain of debt is held by financial institutions within China’s borders. The powerful Chinese government may well intervene to soften Evergrande’s fall, even if it’s not willing to prevent it entirely.
But we’d be naive, and ill-prepared, to imagine the rest of the world is going to escape unscathed.
To put it simply, Evergrande is a very big deal to China, and China is a very big deal to the rest of the world. If China catches a cold, the global economy will sneeze. And China is about to catch a pretty serious cold.
Evergrande’s debts are not just massive; they also have many, many tentacles. The company owes money to nearly 300 banks and financial entities. Individually, the exposures may be small – as many lenders, especially those outside China, have quickly assured their investors in the past week. But collectively, it’s a pretty wide-spreading fog of risk.
Then consider how that fog could affect every financial institution and large client to whom those banks lend. Not to mention the numerous other players in the Chinese property sector who have their own debt problems, which could quickly come to a head as the Evergrande crisis deepens.
This is how credit crunches happen.
“There likely will be financial contagion within China,” economist David Rosenberg, of Rosenberg Research in Toronto, said via e-mail. “This event exposed the depths of the property and debt bubble in China, which is in the process of bursting.”
And what a huge bubble it is. The real estate sector has swelled to take a dominant role in China’s economy, accounting for 29 per cent of gross domestic product.
“It is hard to see how a significant slowdown in the Chinese economy can be avoided, even if banking problems were contained,” Harvard University economist Kenneth Rogoff wrote in a commentary last week.
That “significant slowdown” would be in an economy that makes up nearly one-fifth of global GDP, and an even bigger share of global growth.
“Therein lies the problem for the rest of the world. Size matters,” Mr. Rosenberg said.
“The spillover to growth in the rest of the world will undoubtedly be materially affected to the downside, all the more so for commodity-sensitive currencies and markets like Canada, seeing as China consumes half of virtually every basic material there is on the planet.”
Mr. Rosenberg doesn’t believe that Evergrande represents a “Lehman moment” for China – referring to the 2008 collapse of U.S.-based investment bank Lehman Brothers, which was a key trigger of the global financial crisis. But he does see parallels to the Asian crisis of 1997-1998, which burst debt-drenched property bubbles and caused currencies in the region to collapse.
That crisis, too, began with calm assurances it was a regional problem confined to a few specific markets, with limited exposure globally. It ended with enough global damage to financial markets, commodity prices and asset values that it became known as the “Asian contagion.” The world’s finances have only become more interconnected since.
Obviously, the timing of this is pretty awful. With the world still wrestling with the Delta wave of the COVID-19 pandemic, and trying to keep an uneven and uncertain recovery on course. We could all do without this new kick in the head.
Still, it may be quite helpful that the world’s central banks have very recent experience on how best to keep credit flowing in a rattled global financial system. We already have mechanisms in place, or at the ready, to nip any credit contagion in the bud.
While that may not prove necessary, it’s far more likely that policy makers – not least the Bank of Canada – will need to adjust their thinking to confront the economic threats that lurk behind the current public drama. They need to start gauging those risks now, before the fast-evolving situation leaves them behind.
History has taught us that while it’s fine (and only human) to hope for the best in such situations, one should prepare for the worst.
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