Will China Do What Uncle Sam Should Have Done in 2020?

Whatever your personal feelings about the People’s Republic of China, there’s no arguing with one salient point. Since what we once called “Red China” embraced capitalism in the 1980s, Chinese entrepreneurs unleashed an explosion of growth and wealth.

Indeed, by allowing free markets to function, China experienced what was likely the largest collective increase in wealth in human history. Hundreds of millions of formerly impoverished Chinese citizens have joined the middle class.

But “capitalism” in China is hardly unfettered. While a significant degree of economic freedom exists, there is near-zero political freedom, and press freedom is non-existent. The ruling Communist Party owns or effectively controls nearly everything, including the central bank, the four largest commercial banks in the world, and many of the country’s largest companies. Not to mention WeChat, the world’s largest social media company, with more than one billion users.

That means when the Communist Party—and specifically President Xi Jinping—decides to shift course, there are few if any, checks on his power to do so. In recent years, Xi has announced a long-term goal of what he calls “common prosperity.” The campaign is a combination of rooting out corruption and showing tech billionaires like Jack Ma who’s the real boss.

Now, the “speculative” model of modern capitalism is in Xi’s sights. Last summer, the government imposed a set of limits on corporate borrowing, known as the “three red lines.” Xi wants to end or at least restrain an economic model driven by debt and speculation to defuse potential political risks to the long-ruling Communist Party.

And nowhere in China is an economic sector as indebted as the property market. A case in point is Evergrande Property Services, China’s second-biggest property developer. The company’s outstanding debt comes to $305 billion. And it’s run out of cash thanks to Xi’s crackdown, combined with a slump in property sales and prices.

Evergrande has already defaulted on some bond payments, and at least four other Chinese property developers are also in financial distress. So naturally, Evergrande and its rivals are invoking another ritual that’s become part of modern capitalism—asking for a bailout. And they’re not alone. Foreign investors in China’s $200 billion international high-yield bond market, which is dominated by property developers, want a bailout too.

And when we say high yield, that’s what we mean. Before the crisis began, these bonds offered yields of 10% or more. The average yield on high-yield Chinese corporate bonds now exceeds 20%. Foreign investors who bought these bonds believed that if push came to shove, China wouldn’t let the companies that sold them default. After all, China had previously done exactly that. Indeed, only two months ago, the government bailed out the country’s largest insolvent bank, Huarong Asset Management.

Just to make sure China’s decision-makers got the message, last month, an American delegation composed of C-suite executives from some of Wall Street’s most influential investment banks and hedge funds sat down with Chinese regulators to review the latest developments. We’re not privy to what was discussed. But we suspect that Wall Street wants a bailout for the leveraged positions they’ve taken in this market.

What they have in mind is probably a rescue package similar to the one carried out by the Federal Reserve and Congress as the COVID pandemic unfolded in the spring of 2020. Between March 12 and April 9, 2020, the Fed created $1.77 trillion out of thin air and handed it to Wall Street to prop up asset prices or to bail out the (mostly) billionaires that owned them. The Fed could just as easily have sent 130 million checks for $13,600 to every household in America. But as Wolf Richter, one of my favorite economic commentators describes it “this was helicopter money exclusively for Wall Street and asset holders.

Meanwhile, Congress enacted its own bailout bill, part of which handed $454 billion in borrowed money to the Fed, which used these funds as “equity” to create a $4.5 trillion pool of capital to purchase distressed bank loans and corporate debt. We observed then that the banks being bailed out were the same ones that had converted billions of loan loss reserves into profits through creative accounting since the last financial crisis. At the time, we criticized this policy as “socialism for the rich.”

Back in China, Evergrande is unlikely to get a US-style bailout. The Communist Party’s official policy is, “housing is for living, not for speculation.” What’s more likely to happen is that whatever cash is left or still coming into Evergrande and other financially stressed property development companies will be used to complete the projects millions of Chinese homebuyers have already made down payments on. Shareholders in these companies will almost certainly be completely wiped out. Bondholders will receive, at most, pennies on the dollar.

Frankly, we would find that policy refreshing, assuming that’s what Xi actually decides to do. In the meantime, we’re waiting for the moment when Congress and the Fed decide to hold America’s home-grown speculators accountable for their actions, rather than the taxpayers. But we’re not holding our breath.

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