The Drip #10
Evergrande, the Fed, and a New Economic Tide
Before we get into the Evergrande story let's first discuss what happened with investors over the past week and why the markets behaved in the way that they did.
When conditions have been bullish, participants actively look for exogenous reasons to sell. Inversely, when condition have been bearish, participants actively look for exogenous reasons to buy. This is the psychological framework that exists on the fringes of markets whether it be at the high or at the lows.
As the equities market runs scalding hot since the March 2020 Covid lows, people are more and more concerned with a market-agnostic pullback – even collapse.
This is the S&P 500 and the VIX – an indicator measuring volatility in the S&P 500. The VIX has been in a consistent downtrend since the lows of 2020 which indicates a broad market sentiment of continuation within the same momentum without volatility. Historically market insiders have used the VIX to establish market fear among broader participants.
From a technical standpoint this puts a perfect frame over our current view of the market. Things looks drastically overheated and in dire need of a correction; so that just leaves the exogenous market event to decide that for us.
Evergrande and the Chinese Bailout Machine
Evergrande is a Real Estate Holdings company that purchases and develops property in China, they currently are the 2nd most valuable real estate holdings company in China. For years they have been racking up debt issuing bonds to investors in both China and overseas to cash in on the booming real estate market, but when Covid hit – coupled with China's extremely strict crackdown – their plans spoiled. The company was left with 25% of their portfolio vacant and tens of millions of revenue to pay their debt obligations missing, $300 billion dollars of debt to be exact.
While they are the 2nd largest real estate developers in China, they also have their hands in many other pots, including:
- Electronic Vehicles
- Consumer Products
- Healthcare Products
- Phone and Television Products
- Theme Parks
This shows just how vast the spread of defaults could be if contagion were to occur. In order to shore up cash to pay obligations of their debt they'd need to sell assets of their real estate portfolio. With the real estate market in China as leveraged and overheated as it's been the second largest real estate developer wouldn't just be able to dump its portfolio on the country. Every other company and individual investor with a real estate portfolio would look to cash in on the event as to not miss timing the top. A deleveraging event much like in crypto would occur, in which would lead to outright contagion and an end to the housing bubble.
That would be the worst case scenario and what markets were worried about at the beginning of the week. Every company would be at threat of defaulting as the sale of their assets likely would not be enough to pay off their own debt obligations and then you have a roiling cascade of underwater companies with bad debt. A lot of companies, like Evergrande have their fingers in other industries which would lead to knock on effects outside of real estate as well. Furthermore, a lot of bigger companies issue bonds to foreign investors who will also take losses causing ripple effects in global markets as well.
In our eyes we don't see this being as much of a global threat to begin with, China isn't as connected to the global economy as many conclude – in debt terms – and they will likely deal with this how they've dealt with similar events; cycle through their bailout machine.
The Bailout Machine
China is a 'win at all costs' economy. In that in order to achieve it's nationalistic goals it must run a long-lasting and efficient domestic economic machine. China is a 21st century state-capitalist country, this means that the government is the main economic player.
This means companies are state-owned but privately managed. Local governments maximize profit efficiency between intra-industry companies even though they are all owned by the state, a sort of controlled free market, the oxymoronism of China at its peak.
The same phenomenon goes for banks as well. Some banks are state owned but privately managed. This is where things get tricky.
While the CCP (Chinese Communist Party) has an absolute hold on the information the world gets to consume on the inner-workings of China, we can still put together the pieces where money goes, doesn't go, and sometimes disappears. China uses multiple state-owned banks to loan money out to state-owned companies and washes those loans through their banking system by creating zombie companies to do unneeded work. This is evident in all the 'ghost cities' littered throughout China in which massive operations were undergone to build cities no one occupies. As China continued to build out it's middle class, bad loans were repeatedly cycled in similar fashion across the country until wage demand levels met over-production levels over the past decade.
This bailout program of nationalizing debt by securing companies under state-ownership and running their debt through state-owned banks is concerning for foreign investors and will likely be a huge topic over the coming years.
The thesis that public sector backstops will become the new financial system's paradigm is increasing. China has created an efficient way to continually increase its production and other countries must follow to keep up.
Enter the United States Federal Government.
The FOMC Meeting
As inflation talks ramp up, the market extends to unprecedented levels, and Covid continues to linger, the party music is starting to fade. Slowly coming to a head we are going to see if the last 18 months of QE has done its job at stabilizing the economy without $120 billion dollar a month injections.
The Fed needs to continue QE well into 2022 without hiking interest rates back up. In order for that to work inflation numbers need to be normal, jobs report needs to be normal and consumer demand needs to be normal. None of which are currently satisfying that requirement.
I think the Fed got lucky with the Evergrande situation being as blown out of proportion as it was, as to be a direct reason for not announcing a taper date. Instead they said that moderate tapering could be necessary soon and have increased the taper rate from $10 billion a month to $15 billion a month. This to me seems like optics and psyops to show a fake-Hawksih fed.
The reality is no date was given and we are one 'controlled' catastrophe away from extending QE without a taper.
The US Treasury is fighting to lift the debt ceiling as they run out of cash to institute fiscal policy, another concern for markets.
This entire article should be entirely worrisome if you've been connected to financial markets before 2008.
The New Monetary Paradigm
The fastest growing economy by nominal GDP in history is China, and because of what we explained above, they are positioned to continue over-producing goods and meeting global demand only to grow larger and larger. China has always been ran by the state and has created it's own economy in which survives in reflection to the health of the state. The economy fails, the state fails. That cannot happen so all policies must prevent that from happening.
Does this sound like a familiar paradigm in recent history throughout democratic states?
The United States remains the number one country in nominal GDP and must continue to hold that title if it seeks to hold strong militaristic, economic and political influence across the globe. The same fight that's been going on for the past century, except the front lines are economic.
The seed was planted after the Global Financial Crisis as we began expanding the Fed balance sheet. This gave more power to the state than we realized. The United States economy has been thriving on lack of foresight for decades, this is no different, a phenomena I have talked about before.
As the Fed continues to provide a backstop for the economy a reliance on its policies will lead to a systemic economic shift much closer mirroring China than the perceived consensus of the current United States. The Fed and the Central banks act as a public sector, state-owned conglomerate that continues to keep the United States economy afloat and producing, much like China and it's bailout machine.
Already we have seen much more reliance on these FOMC meetings over the last decade than we ever did before. This isn't something that occurs overnight, this is a growing thesis I have had over the years and will likely play out over the next few decades. This is the economic shift of a global empire in a world the fights on economic battlegrounds.
How crypto plays into this I am still observing.