China Minsky Risk: The Evergrande Wake Up Call

Axiom number one. Inflation depends on the growth of money.

Axiom number two. Asset price bubbles depend on the growth of credit.

Kindleberger and Aliber’s - Manias, Panics, and Crashes

Vienna 1th May 1873: The 1873 US and Europe panic wake up call

Many investors in Austria, invested great amount of money expecting an increase of the business activities in the occasion of the World Exhibition, increasing their liabilities far above their assets, so facing acute financial distress risk.

As seen that this event had the goal to improve business activities and to host many people from all the world, there were many investments in facilities designed to accomodate the attendees at the fairs.

The credit was stretched to the limit, a move from commmodities, land, shares, and debt into money was under way and the chain of accomodation bills was extended as far as it would go, nonenthless banks continued to push the limit hoping that the event could increase nation cash flow and so banks interests could be repaid.

When the exhibition opened the sales were disappointing and between 5th and 6th of May the market collapsed.

Prussia 1763

Frederick II of Prussia bought vast amount of silver in Amsterdam to provide for a new coinage to replace that which had been debased during the Seven years war, but liquidity wasn't enough so he instead used credit.

The move that pushed Prussia to serious problem was that, he withdrew the old money from criculation, before new money was issued, causing a deflationary crisis and collapse of discounted bills

Asia Credit Cycles

Asia has recurrent credit cycles, that eventually ended with speculative crashes.

A period of economic growth, without the apparent emergence of fundamental macroeconomic imbalances generates optimistic expectations that cannot be sustained for extended periods of time. In fact during Asian crisis of 1991-96, four of the five countries who faced it the most, registered 7% annual growth rate, even if CPI index in some of locations didn't show significant inflation rise during early 1990s

Evergrande: Why a wake up call?

Evergrande Real Estate Group one of the leading firm not only in Asia but globally, with a total accumulated asset of real estate amounted to approximately 2.3 trillion yuan (2020).

1) -> What should have opened our eyes

Evergrande Group showed weaknesses and real issues by long time:

- The propriety under development segment manatined a 59.04% average ( as % of

current assets) and a 49.22% average ( as % of total assets )

- Cash & Equivalents decreased by 36.52% from 2016 to 2020

- During past 5 years the debt section on the balance sheet was signaling a dangerous situation:

2) Why a wake up call?

- No, i do not think Evergrande will be a Lehman case. But it could signal something worse.

Wait a minute. This doesn't mean that the fall of the firm will be like 2008 sub-prime crash.

No. This gonna fade in weeks, and after the inevitable default, Chinese governemnt probabily will take control of the company activating a restructuring.

But why worse?

Because it's segnaling something big. It's not Evergrande itself that will establish the "end of the road", but we should worry about the credit system and debt dangereous trend.

2.1) Buying something you cannot afford by using credit

By analyzing domestic credit trends in China, we can easily see a sustainable growring rate from 1977 to 2002/03 when the correlation with global and US diminished, continuing to follow the rising trend line.

2.2) Bank loans and debt securities issues

Total credit to non-bank borrowers during latest 2020-2021 Quarters reached the highest level in China Mexico and Indonesia.

Conclusion: Minsky Model and Evergrande alarm

Many analysts proposed that China could be near to a Minsky Moment so "the onset of a market collapse brought on by the reckless speculative activity that defines an unsustainable bullish period".

Minsky Moment crises generally occur because investors, engaging in excessively aggressive speculation, take on additional credit risk during bull markets.

My view is that, China Market is not the only one exposed to this risk.

Nowadays we're in a debt trap and whatever we're talking about financial or non-financial sectors, the rates are all time highs,

And why Evergrande hasn't put fear on investors, or just say 2008 fear?

Even considering the 300B debt, the default forecast, and the expectation of governament take over, diffusion level is not comparable.

The problem can be curbed by the government by using liquidity and by letting the company fall

Also, this event doesn't belong to a systematic problem involving multiple external investments as in the Asian crisis of 1991 for example.

But don't even start to think that, what happens in China remains in China.

The biggest exporter of the world; Biggest reserve holder; Fastest growing economy.

What happens in the world, affects the world.

Keep your eyes open, this event could be our wake up call.

This post was prepared by Andrea Manzi in his personal capacity. The opinions expressed in this article are the author's own and do not reflect the view of the company or the University or any other person. Website and the information contained here are not intended to be a source of advice or credit analysis with respect to the material presented, and the information and/or documents contained in this website do not constitute investment advice.