BALTIMORE, MARYLAND – Evergrande it ain’t.
What we are wondering today is what’s ahead for the U.S. economy – inflation or deflation? Maybe the Evergrande story will give us a clue.
To fully understand the Evergrande story, you almost have to understand the whole story…
…of how, in 1971, the U.S. switched to a “flexible” dollar that it could print at will…
…and how the switch created a boom in China… and a bust in U.S. manufacturing (it’s easier to “print” money than to make refrigerators).
In an honest economy, pre-1971, the U.S. had to repatriate its dollars by offering equivalent quantities of goods and services to the Chinese…
…or risk having to settle up in gold.
But with the new system… it could just print up more dollars… which the Chinese, bless their hearts, used to buy U.S. bonds…
All this money created a boom in China… which quickly got out its cement trucks. The concrete flowed like the Yangtze.
We saw the construction boom on our trip to China in 2014 – a breathtaking display of human industry and material progress.
The highways were new. The buildings were new. The trains… docks… factories – all new. You could scarcely find a house more than 18 months old.
Never in the history of the world had so many people gone from being so poor to so rich in so short a time. Per capita income rose from $318 in 1990 to $10,500 in 2020.
And never in history had so much money been borrowed to make it happen. From $1.7 trillion of total debt in 2000, China now owes nearly $50 trillion. Its debt-to-GDP ratio now stands at 335%.
China’s economy grew by leaps and bounds. People were working harder than ever… and earning more and more money. Surely, they would want to buy places to rest their weary heads?
Property developer Evergrande saw the demand coming, and borrowed heavily to meet it. In this regard, it was particularly resourceful. Bloomberg’s Matt Levine reports:
Evergrande owes money to Chinese banks. It owes money to foreign hedge funds, and foreign investors own its stock. It owes money to suppliers, and to Chinese retail investors in those wealth management products. And it owes apartments to buyers. And the retail investors who bought Evergrande wealth management products were often also Evergrande homeowners, because the products were sold at Evergrande buildings.
Yes, the company advertised its own debt to its employees and customers, as suitable for “conservative investors seeking steady returns” – promising 11% per year.
And now, it owes some $300 billion… with no way to pay it. The Financial Times reports on the fallout:
China’s property slowdown sends chill through the economy
And so we wonder: What other Evergrandes are waiting to be discovered? What other excesses are waiting to be reckoned with?
The whole debt-drenched U.S. economy, perhaps?
U.S. government debt has gone from under $1 trillion in 1980 to over $28 trillion today, a 28 times increase.
That would have been fine if the economy had kept up.
But it didn’t. U.S. GDP in 1980 was $2.8 trillion. Now, it is almost $23 trillion, an eight times increase.
As Evergrande has discovered, debt only makes sense when the rate of return on the investment is greater than the cost of the debt.
That’s hard enough to do for a private company, with a keen sense of business… and owners with skin in the game.
For the U.S. government, it’s been impossible. As we showed earlier this month, all of its major investments over the last 50 years have been losers.
Nowhere to Fall
But there’s a big difference between the debt bubble in the U.S. and the debt bubble in China. Evergrande built houses. And malls. And commercial buildings.
And now that the supply for these things is greater than the demand, prices will fall.
What did America produce? What prices will fall in the U.S.?
Factories? Nope. U.S. manufacturing has been in a decline the entire 40-year period.
Housing? Nope again. In the 1950s, America built 21 million new houses. But in the decade from 2010 to 2019, fewer than 6 million were built.
Autos? Nah, the U.S. produced around 9 million vehicles last year… almost no increase from the figure 10 years ago.
During that same 40-year period, in which real output rose eight times, the Dow rose 33 times. The Nasdaq line was so close to the zero line in 1980, you couldn’t squeeze a greased penny between them. Now, it is nearly 15,000.
In 1980, household wealth (stocks, bonds, real estate) measured about 350% of GDP. Today, the ratio is over 600%.
And, of course, in the Evergrande scheme of things, the excess was financed by debt.
Total U.S. debt (including households, government and business debt) stood at 1.65 times GDP in 1980. Now, it is 3.78 times as great.
There, then, is the excess. And there is the bubble that is about to burst.
Tomorrow, we will look at what happens next.
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