For the first time since the bankruptcy of Lehman Brothers in late 2008, there is a serious risk of global financial contagion.
That is, it is possible that investors, en masse, will withdraw their money from large institutions around the world and these banks in turn may not be able to meet their own funding obligations or loan.
This is colloquially called a “credit crunch”.
If this happens, much of the economic activity will stop and unemployment will rise.
You find yourself in a deep global recession, as happened in the 2008 global financial crisis after the collapse of Lehman Brothers.
This week we might see a development that has the potential to spark such a series of events.
What is the event that concerns us?
China is the second largest economy in the world.
Its real estate sector accounts for 25 percent of gross domestic product or GDP.
Evergrande is China’s second-largest real estate developer, the most indebted in the world, and it is in serious financial difficulty.
Inside sources told financial news service Bloomberg that Evergrande had already missed interest payments to two of its largest bank lenders on Monday.
The company is now due an $ 83.5 million corporate bond interest payment tomorrow.
Financial markets speculate that he won’t be able to do so, although he has a 30-day grace period before a missed payment is formally a default.
But these interest payments are just the tip of the iceberg. The company has a total debt of approximately $ 305 billion ($ 419 billion).
Do you see where this is leading?
AMP Capital’s chief investment officer, Shane Oliver, says there is a “serious risk” of financial contagion.
“This could trigger contagion through the Chinese credit system, making it more difficult for other real estate developers and other borrowers to obtain funds,” he warns.
The implication for Australia
A Chinese real estate crash would cripple the Chinese economy.
China is Australia’s largest trading partner, which has obvious and significant ripple effects on Australia’s economic growth, stock market and pension balances.
“If there is a major collapse in the Chinese real estate market, it has a major effect on economic growth, which of course has a huge impact on global growth, and of course is bad for Australian commodities,” explains Oliver.
The BHP Group is already down 30% from its high at the start of the year as the price of its flagship iron ore has slumped by more than 60%, although from record levels.
The stock market has also just hit all-time highs, and analysts say they will be easily scared off by any news that might shake investors.
Plummeting stock markets also have the potential to drag economies down, as companies pull back investment plans and delay hiring workers.
Risk of global financial crisis
However, there is another financial bogeyman.
Many emerging countries, including China, borrow in US dollars.
Currently, there is a total of $ 4 trillion in outstanding debt held by all emerging economies, according to Canadian research and analysis firm BCA.
China’s outstanding external debt, according to China’s State Administration of Foreign Exchange, stands at $ 2.2 trillion.
Investors fear that while there is even a suspicion that some large Chinese companies may have trouble meeting their foreign debt obligations, other emerging economies could quickly find themselves in trouble.
It’s a reminder of the Asian financial crisis of 1997 and 1998, and other emerging market US dollar debt crises before and since.
This presents the risk of another global financial crisis, according to private investor and financial writer Danielle Ecuyer.
This is especially the case if global nervousness over the changing real estate market in China is driving investors to buy billions of US dollars as a safe haven.
“The double effect – the slowing down [Chinese] economic growth, or problems in the real estate market, and you have debt denominated in US dollars, and the currency (US dollar) is getting stronger – then you can see how the payments become more unsustainable, âsays Ecuyer.
That is, other large Chinese companies would risk struggling with their own debt repayments because the value of the US dollar rose.
Evergrande’s problems risk being “closed”
Let’s not get carried away.
Shane Oliver and Danielle Ecuyer have said the Chinese government will try to restructure Evergrande’s debt.
The Chinese team of global banking giant Barclays also points out that most of Evergrande’s approximately 2 trillion renminbi ($ 419 billion) debts are domestic unlike, for example, the Lehman Brothers World Expo.
âMore than 50 percent – over RMB 1,000 billion – is accounts payable and acceptance bills,â they note.
“Another 279 billion RMB – $ 42 billion, or 14% of liabilities – are wealth management products (WMP), sold to retail investors [mainly Chinese households].
“These could be a source of social problems in the event of large-scale default. [Chinese authorities have bailed out some WMPs in other cases, but each case seems to be handled on its own merits]. “
Rabobank analyst Michael Every also believes financial risks will be contained.
“He’s a real estate developer, not a bank,” he says.
“We are well aware of the vulnerability of the international system today from top to bottom, left to right, when before Lehmans there was this assumption that everything would be fine.
âAnd most of what happens will be confined to China.
“There is a way to thread the needle, potentially.
“You can then bail out ordinary households and say ordinary people shouldn’t be affected and, more importantly, on the other side, what Evergrande should look like if it still exists.”
Iceberg to come
That risk, however, is that Evergrande is just the tip of the iceberg in terms of corporate debt exposure, and global financial markets are anticipating this in the coming days, causing all assets to sell off.
European banks, according to Bloomberg, are directly exposed.
They include UBS and BNP Paribas, with other global financial giants such as BlackRock and Royal Bank of Canada also in the crosshairs.
It’s unlikely to be another Lehman Brothers moment just because Evergrande isn’t an investment bank, and we’re unlikely to uncover a trillion-dollar global chain of asset-backed securities. worthless mortgages held by major investment banks, as happened in 2008.
However, China’s ability to contain a financial catastrophe is about to be tested, and if it fails, an overexcited and leveraged financial system may not be able to cope with the fallout.
The global financial system may well be facing its biggest test since the global financial crisis, even as economies struggle to regain ground lost to the COVID pandemic.