Thread by @michaelxpettis

1/14
Very thoughtful (as usual) piece by @adam_tooze on observing the Evergrande observers. He asks, at the end, "What if this is actually what a shifting of economic gears looks like?"

adamtooze.substack.com/p/chartbook-on…

2/14
I think Evergrande is more of a premonition of the shifting of gears than the beginning. What typically seems to happen with the high-savings/high-investment development model is that countries start off with many years of high growth and low debt, but as they close...

3/14
the gap between actual investment and desired investment (i.e. the amount of investment they can productively absorb), rather than adjust the model they typically maintain high investment rates.

4/14
This invariably causes debt to surge relative to GDP as the growth in debt-servicing costs begins to outpace the growth in debt-servicing capacity. This ultimately isn’t sustainable, and I’d argue that Beijing probably realized this a few years ago.

5/14
But as Albert Hirschman pointed out many years ago, it is nonetheless difficult to shift to a new growth model because constituencies that have disproportionately benefitted from the old model tend to be disproportionately powerful politically, and block attempts to adjust.

6/14
As a result we see rising strains in the financial system that often manifest themselves as a series on mini debt-related crises. This probably already started many years ago, but certainly by May 2019 with the collapse of Baoshang bank.

7/14
Baoshang was followed by a series of bank and large corporate and SOE interventions the most important of which, in my opinion, was not even Evergrande but Huarong.

8/14
So what next? I think policymakers in Beijing who understand that the system is unsustainable have been frustrated by their inability to address it in the past. This year certainly isn’t the first year that regulators have tried to...

9/14
suppress debt, undermine moral hazard, clamp down on real estate prices, etc., but in the past time each time they did so, as the costs of doing so became apparent, they were forced to back down.

10/14
Perhaps Evergrande is indeed a turning point, and the regulators will allow whatever damage is required to clear the system and the transform the country’s growth model. Among other things this will mean that until there is a major transfer of income from...

11/14
local governments to households (which will not be easy at all), China will have to accept much lower growth rates. My limited ability to eavesdrop on what policymakers are discussing, however, suggests that they are not there yet.

12/14
My guess is that Evergrande will soon be “resolved” in a way that minimizes pain where that pain is politically most worrying and allows pain where it is less politically worrying and where it might do some good in undermining moral hazard.

13/14
But I don’t think Beijing has decided that this game is over: that it will cut China’s property sector down to a more reasonable size and will stop local governments from borrowing as much as they need to achieve GDP growth targets.

14/14
I hope I am wrong, but I think we probably have another year or two before Beijing is determined to force through “a shifting of economic gears”, and until then we will see more mini debt crises, perhaps not as spectacular as Evergrande, but painful all the same.