Thread by @prchovanec

There are three immediate possible outcomes to the Evergrande crisis:

1) the Chinese government allows Evergrande to fail while containing the panic and insulating the rest of China’s economy.

2) the Chinese government loses control of the situation, contagion takes over, and China finally faces a broader financial crisis.

3) the Chinese government papers over the situation, socializes the losses, and pretends the problem has gone away while I actually festers and grows worse.

The outcome in the past has, for the past decade or so, always been #3. Will this time be different? The truth is, nobody knows. Least of all the people in charge.

I wish there were some more scientific way to say which will happen. The only thing that can be said is that the underlying problem is very real and very big.

One thing that is important to note is that China does not have - despite many people insisting it does - a foreign exchange crisis. At least not yet, as far as we know. It has a domestic debt crisis, which has very different (though serious) implications - and solutions.

That’s not to say that foreign lenders into China don’t face the risk of loss. Just that this risk does not derive, for now, from lack of systemic access to FX, but from the credit risk of the investment itself (which may well have other systemic aspects, besides currency).

The one thing that could change this (as far as facing an FX crisis or not) would be mass capital flight from China. But there are a lot of obstacles to this happening. Not impossible, just not easy.

The fundamental problem here isn't Evergrande's creative bookkeeping, or its ventures into soccer etc. It's China's reliance on buoyant real estate collateral as the lynchpin of its entire, broader banking system.

Too much lending in China, to every sector, not just property development, depends way too much on the assumption that real estate will always go up in value, and that if you build it - anything - they will come.