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A general view of the Evergrande Changqing development in Wuhan, Hubei Province, China. (Getty Images)

Chinese real estate giant Evergrande—debt-laden with liabilities amounting to three percent of China’s GDP— is on the brink of collapse, and the conglomerate's default would leave no global market untouched. Given the Chinese Communist Party's efforts to "advance the state" and its unchecked reliance on debt-fueled investment, will investors finally start to take Beijing's market manipulation seriously?

In a new policy memo [[link removed]], former Australian national security advisor and Hudson Senior Fellow John Lee [[link removed]] examines how Evergrande's woes are symptomatic of broader issues emerging in the Chinese economy, which is struggling with enormous debt, an overreliance on the real estate sector, and the CCP's tightening grip on the levers of economic power. See key quotes from John's research below.

Read the Policy Memo [[link removed]] Download the PDF [[link removed]'s%20Evergrande%20Dilemma.pdf]

Key Quotes

1. The Bigger Picture: China's Debt-Laden Giants

Like Evergrande, much of the Chinese political economy is driven by churn and forced activity; measurements such as return on capital or profitability are not used to allocate resources or guide commercial decision-making. Price and market signals in major sectors are suppressed to achieve political objectives.

The problem for the CCP is that it has enabled the emergence of giant, inefficient, and debt-laden firms such as Evergrande. To explain how, consider the common and accurate description of the economic situation in China: “the state advances—the private sector retreats.” Under Xi Jinping, the unequal treatment of the private sector has been extended further: State-owned firms and well-connected private firms are being offered easier and cheaper access to credit, privileged access to some of the most lucrative sectors in the economy, and regulatory and legal protection from local and central governments.

2. Debt, Not Demand, Drives China's Real Estate Boom

Evergrande’s model of “three highs and one low” (high debt, high leverage, high turnover, and low cost) was widely assumed to be ready-made for a period of rapid urbanization, and that this rapid Chinese transformation from rural to urban was driving the enormous investments in real estate.

This is only partly true. It is estimated there are presently enough empty homes in China to house 90 million people, which would meet the country’s urbanization needs for the next decade and beyond. The massive increases in real estate construction are not driven by urbanization needs. Instead, they reflect local governments’ efforts to raise revenue by appropriating rural land to rezone for industrial or residential construction—regardless of actual housing demand.

3. The Future Reckoning on the CCP's Domestic Spending

The strong odds are that China can avoid any Lehmann Brothers moment. The CCP can instruct state-owned banks to lend to each other and can prevent defaults appearing on the ledger by forcing the rollover of loans and extension of bond interest payments. That is the perverse resilience of the Chinese economy even if it means kicking the can down the road and creating a more severe reckoning for future generations.

Evergrande’s plight offers strong evidence of the structural slowdown that China will endure. This will have longer-term implications for the resources the CCP can direct toward domestic security and external strategic objectives, given overspending on the former and underspending on social and public goods. That underspending will become more glaring as Chinese society begins to rapidly age.

Quotes have been edited for length and clarity.

Read the Policy Memo [[link removed]] Download the PDF [[link removed]'s%20Evergrande%20Dilemma.pdf] Go Deeper

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