This comment by me, supporting a comment by @ChinaBeigeBook, seems to have set off plenty of discussion and debate. The point I would make is that a financial collapse is the result not of insolvency but of...
a balance sheet mismatch, although of course insolvency can help create or exacerbate these mismatches. I argued in my 2001 book that they occur when assets and liabilities on the borrower's balance sheet are inverted or...
otherwise highly mismatched, so that a sudden liquidity shock can cause a rapid contraction in the liabilities that cannot be matched by an orderly or equivalently rapid liquidation of assets.
On paper Evergrande and many other large borrowers in China (including most local governments and property developers) may seem to have very risky balance sheets, but in fact as long as China's financial system...
is largely closed (i.e. foreign financial inflows are limited) and the regulators highly credible, they can effectively restructure liabilities at will, so that the contraction in the liability side of the balance sheet can be limited to the pace at which...
assets can be liquidated in an orderly way. When things get bad, in other words, the regulators can easily step in, and always have, to slow down or reverse the liquidation process.

Over time this can change, of course. As China continues to open up its financial markets...
to foreign hot money, the first condition is undermined, and sharply rising debt levels can undermine the second condition by eroding the credibility of the regulators, but for now I continue to think a financial breakdown is very unlikely.
This doesn't mean there isn't a problem. A financial collapse is just one way excessive debt is resolved, and while it can be socially and politically brutal, it is quick. More gradual resolutions are almost certainly worse for the economy over the long term.

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More from @michaelxpettis

17 Sep
"Current estimates put the size of the capital injection Huarong needs at around 100 billion yuan. Citic Group will provide the lion’s share of the funds, between 20 billion yuan and 50 billion yuan, most likely raised through bond issuance."

Now that Huarong's intervention has been completed and it is in the process of recapitalization, it's easy to forget about it, but the ways in which the authorities dispose of Huarong's assets will tell us something about how future large insolvencies will be treated.
For now they seem to be moving quickly to liquidate assets, which is a very good thing, although it is not clear if these will be sold at clearing prices or whether there will be pressure on buyers to pay whatever amount Huarong needs to be remain technically solvent.
Read 4 tweets
16 Sep
This is an interesting problem for central banking geeks. Many of China Evergrande's suppliers, who were paid not with cash but with Evergrande commercial paper (CP), are now finding it hard to get paid, and so are worried about their own...

solvency and liquidity: "The plight of Wu and many others like him has thrown a spotlight on the extensive use of CP in China's property sector. Developers favour it as they prefer to not pay upfront and because it doesn't count as interest-bearing debt."
This is an obvious problem for Evergrande's suppliers, who might not be paid after having delivered products, but, as I plan to explain in my central bank seminar tomorrow, it is in fact also a monetary problem. As long as CP from large property developers was...
Read 7 tweets
16 Sep
Very useful thread. I think the most important point is this: "You will never make a loss if you never acknowledge the expense of malinvestment - i.e. if you never write anything off. If you don't expense your losses, they show up as assets on your B/S."
This is something economists (but not traders) seem to have real trouble understanding and incorporating into their growth models. Losses should always be expensed, and so should reduce income and wealth, but when they are instead capitalized, they show up as...
higher income and wealth than is economically justified. A company (or country) that systematically capitalizes its losses will seem to grow faster than one that doesn't and will show higher levels of net equity, but that growth and those assets are fictitious.
Read 4 tweets
16 Sep
Problems at Evergrande seem to be spreading financial distress costs through the residential property sector. According to Caixin: "Home sales by value slumped 20% in August from a year earlier, the biggest drop since the onset of...

the pandemic shut down swathes of the economy at the start of 2020. New-home prices in 70 cities rose 0.16% last month from July, the slowest pace this year. Prices on the secondary market dropped for the first time since February 2020, slipping 0.02% from a month earlier."

This is normally what happens when a company or sector flirts with insolvency: buyers, suppliers and creditors become more cautious, managers more distracted as they focus on financial rather than operational issues, and employees become...
Read 6 tweets
15 Sep
Three different estimates suggest that hidden local-government debt, mostly in the form of borrowing by LGFVs, amounts to roughly 45-50% of China's GDP. The authorities have been trying for years to clamp down on this hidden debt but, as Caixin...

points out, "new measures to control local government liabilities and hidden debt were frequently followed by innovative ways to get around them, prompting policymakers to tighten supervision of debt management further to try and close loopholes."
This has been the case for well over a decade. The problem is that local governments are supposed to deliver the economic activity that allows China to achieve the GDP growth target. This was easy in the 1990s and 2000s, when much of China was still severely underinvested.
Read 10 tweets
14 Sep
China Evergrande is trying to restructure payments on its wealth management products. "These products, offered through its internet finance affiliate, Evergrande Wealth Management, are owned mostly by its own employees."

scmp.com/business/artic… via @scmpnews
I would imagine that Evergrande employees, now worried about losing not just their jobs but also their savings, are unlikely to be especially well-disposed to their employer. Under these circumstances, any potential clients willing to overcome a natural reluctance...
to buy from Evergrande will have also to deal with inattentive or even truculent agents.

By this stage, it is usually too late to resolve the problem internally. Revenues will drop further, efficiency will decline, debt-servicing costs will rise, and liquidity...
Read 6 tweets

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