Collapse of the CCP — Scenario 1

The CCP and its fiefdoms are funded by a real estate sector under threat.

Update Nov 2021. Heavily indebted Chinese developer Kaisa Group had a $27B USD market cap six months ago. Today, it’s at about $7B and trading has halted after it was revealed that 18 of its Shenzhen projects — worth about $13B USD — are up for sale. Kaisa’s 6.5% Dec bonds, which traded at par just two months ago, are now at 52 cents. As of July 2021, the company had about $38B USD in liabilities.

Update Oct 2021. Yango Group, China’s 18th largest developer, has seen its shares fall by about 80% and its Jan. 2022 bonds fall from .90 to .22 in a little over a month. As of Nov. 1, Yango has requested a delay in repayment on three dollar notes. Among the 29 cities monitored by China Real Estate Information Corp, residential property sales declined by 22% YoY and by 12% from Oct 2019. Home sales in tier-2 and tier-3 cities declined 23% YoY.

Evergrande is a Chinse real estate company in the midst of a managed >$300B collapse. (Yes, $300 billion. Almost $90B is interest-bearing debt.)

Bloomberg Oct 8. Source.

The Chinese Communist Party will never let a company of that size — with its hundreds of thousands of employees and investors — simply collapse. Money will be printed and pumped into the gaping financial craters of the Evergrande wasteland. A few of Evergrande’s leadership will be paraded through show trials, and the CCP will (and has) limited open discussion of the real estate market until it creates a workable public narrative for how this occurred (or never occurred) under the supreme competence of the CCP.

Almost $200B of market cap has evaporated this year — and that’s one company. (China Evergrande Group (3333.HK). Trading has been halted.)

Evergrande, in itself, isn’t really an issue. The Evergrande problem for the CCP is, first and foremost, that real estate is the primary way by which the Chinese save money. The aspiring Chinese middle class relies almost exclusively on real estate to enable their dreams. If the aspirational Chinese middle class loses faith in real estate, it may also lose faith in the CCP’s ability to create something akin to middle class wealth. (The Chinese residential real estate sector is valued at about $62T. By comparison, the U.S. residential property sector is about $34T. In China, residential real estate is almost 30% of the national GDP. In the U.S. it’s about 6%. QED: instability in the residential property sector in China is instability for the nation.)

Another Chinese real estate developer. A few billion more lost in market cap. Trading has been halted, and it’s defaulted. (Fantasia Holdings Group Co., Limited (1777.HK))

That actually seems like the smaller of two major problems. The much bigger issue is that regional and local governments are almost entirely funded by real estate sales. More than 80% of regional and local government revenue in China is derived from real estate sales. (In China, the CCP owns all real estate. The local and regional government fund themselves by “selling” real estate to developers; in reality, these sales are actually leases. The Chinese use “sale” to appear normal, and Westerners use “sale” because they don’t know better or they can’t wrap their heads around the idea of a political party actually owning a country.)

Bloomberg Sept 26. Source.

While >80% of local/regional revenue is derived from these real estate sales, about 40% of national revenue is derived from such sales. The CCP is not going to print $300B to bail out Evergrande. Foreign investors will probably lose everything. Many local investors will lose much. But many billions will be distributed to attempt to support the vast network of banks, vendors, and construction/real estate companies that face an existential threat from the collapse of Evergrande. Other real estate companies are similarly facing severe financial difficulties. More money will be distributed.

So how’s this gargantuan real estate market doing? More than 90% of China’s top 100 property developers had declining sales in September 2021 by an average of 36% (YoY). September sales totaled 759.6b yuan ($118BN), down >36% from September 2020 and down 18% from September 2019. Beijing, Shenzhen and Guangzhou saw transaction volume of residential properties decline 30%. Shanghai fell 45%. And China’s real estate market comprises almost half of all global distressed dollar-denominated debt.

What happens if the CCP’s “managed” money printing isn’t enough and the real estate market becomes substantially impaired? The greatest exposure to that market is not any particular sector (finance, construction) but rather the government itself.

The problem becomes even more complex when one considers that a substantial amount of the CCP’s support is derived from the vast billions that get skimmed from the real estate sector. This permitted corruption buys party loyalty. What happens if the payments stop?

Two solutions to the problems of bailing out the real estate (and adjacent sectors) and making up the funding gaps the local/regional governments will endure due to fewer land sales:

1. Borrow money from the seemingly bottomless well that is yourself (by printing it). This ouroboros of debt consumes itself, as we know from countless banana republics (such as Weimar Germany). The CCP can bail out Evergrande, but it can’t bail out the entire real estate sector. Further, the CCP’s national debt is >300% of GDP. Total government debt is >100% of GDP. (CCP financial data always contains some part voodoo, so one can never really be certain.) The CCP is closer to Weimar Germany than many people think.

China’s central government debt (as % of GDP; this is an “official” number, so the actual number is much higher). During the same period, many industrialized countries’ debt increased around 15% … while China’s doubled.

By 1910, Germany was the second largest economy in the world, built on manufactured exports via a mercantilist economy wherein the government actively supported the growth of industry, and it had achieved this feat in about thirty years. (This scenario should sound familiar). The problem is that this growth was increasingly debt dependent. Eventually, the debt eats itself. Then WW1 happened. (Yes, WW1 was caused by Germany’s debt. More on that here.) This doesn’t seem like much of a solution.

2. Increase taxes to compensate for revenue gaps from declining real estate sales. The problem here is that most private citizens around the world do not pay income taxes in the way the Westerners think of income taxes. Governments aren’t generally funded by such taxes; they’re funded by mercantilist efforts (owning the energy sector is the most common). What if those mercantilist funding sources (such as the real estate sector) dry up? Taxing the general private population is a non-starter; every government (from Greece to Mexico to China) knows that’s a recipe for popular revolt.

Ultimately, the problem is that tyrannies derive credibility from two simple posits: (1) that they will kill anyone who opposes them, and (2) their government is competent. The second posit explains why such governments rely so heavily on propaganda; the veneer of credibility must be maintained at all costs. (The credibility of a democracy is that it’s elected, not that it’s competent.)

So the CCP’s primary problem isn’t financial at all. The problem is that the CCP can’t be voted out of office. The institutional non-violent revolution that is democracy isn’t available to the Chinese people. And countries that don’t permit non-violent revolution necessitate violent revolution.

Finally: Is it ironic that the most rapacious landlord on earth is communist? As such governments are wont, the CCP spent the 1960s ridding the country of landlords only to enserf the population itself.