Another debt-laden Chinese property developer is on the brink, with potential repercussions for Australia and the world.
PROPERTY problems in China and the US are emerging as the next test of governments and banks as values fall and debt balloons to dangerous levels.
Similar pressures can also be seen in Australia, with central city high-rise vacancies and half-empty second-tier shopping centres forcing owners to cut values, while in the suburbs a housing shortage is fast becoming a political hot potato.
What’s happening is an unpleasant but predictable result of the rapid rise in interest rates, which might be close to a peak, but could stay at an elevated level well into next year, piling pressure on borrowers already struggling to service their debts.
Layered over a conventional interest-rate driven cycle in property values are COVID aftershocks, including the work-from-home experiment, which has been embraced by more workers than expected, encouraging employers to cut their space requirements.
If there is a single point in the global property sector which could cause a financial crisis in the same way the collapse of the US sub-prime mortgage market did in 2008, it’s the Chinese apartment market where a major developer is edging towards failure.
Country Garden is China’s biggest apartment developer with close government connections but even with friends in high places it appears to be going the same way as another big developer, China Evergrande.
The 2021 collapse of China Evergrande, under a mountain of debt, sent financial shockwaves around the world.
Country Garden is bigger and showing the same signs of distress as China Evergrande, including interest payments missed earlier in August on two bonds issued to banks.
If Country Garden does fail, or must be rescued by the Chinese government, it will send a powerful signal about the poor health of the country’s economy, which is being dragged down by failed stimulus policies, slowing trade with the rest of the world and fear of deflation (or disinflation as it can also be called).
Australia is not directly exposed to the emerging Chinese property crisis but our mining industry has been a major beneficiary of demand for building materials, especially Western Australian iron ore used to make steel.
But the far greater problem is the prospect of deflation, a process, which is the opposite of inflation with falling prices and declining values causing households and business to postpone spending and investment because of a belief that whatever you want will be cheaper tomorrow, so why not wait.
Government concern about deflation is so profound that mere mention of the word is officially banned even though it can be seen in consumer prices, which fell in July by 0.3 per cent compared with 12 months earlier.
Of greatest concern to the Chinese government is the threat of the country entering what’s described as a balance sheet recession like what happened to Japan in the 1990s, a decade of contraction because everyone seemed to stop spending at the same time.
In its simplest terms, a balance sheet recession is a downturn caused by people (and businesses) feeling stressed by the debts they’re carrying relative to the assets they own; a point reached this year in Australia by many households being buffeted by mortgage servicing costs.
The obvious solution to bloated debt levels is to pay back what you owe but if everyone does that economic growth stalls, banks can’t lend (because everyone is fully loaded with debt), and the economy slides into a protracted slump.
In time, China will start to ‘export’ its deflation through lower prices for its manufactured goods, with that process feeding up the supply chain to eventually be felt by suppliers of raw materials, including Australia’s mining and farming industries.
Lawyers eye exit
HOW much of what’s happening is a result of the interest rate cycle, and how much is a result of poor Chinese government decisions are interesting points for economists to discuss.
But there is a reasonable chance aggressive treatment of small countries such as Australia and the Philippines is working against China.
International investors have certainly grown wary of China restricting investment and limiting visits by senior management to avoid being caught in a security sweep, which has already forced some banks and management consultants to quit the country.
Lawyers, it seems, are next in the exit queue, with one of the earliest movers into China becoming one of the first out.
Dentons, which claims to be the biggest law firm in the world, has quietly pulled back, ending a merger with one of China’s biggest law firms, Dacheng.
Marketing itself as a polycentric practice because it does not have a head office, Dentons boasts 21,000 staff in 200 locations in more than 80 countries.
China, however, has become too hot for Dentons to handle because of the difficulty in complying with Chinese security laws, which have been expanded to define even simple activities such as drafting documents and downloading data as spying.
This inability to freely share information between western and Chinese partners exposed everyone to a visit from the security services and potential detention.
Alumina slides
CHINA is not alone in kicking own goals as Alcoa, one of WA’s biggest employers, is starting to discover via the latest environmental investigation into its bauxite mining and alumina producing industry.
Uncertainty about access to bauxite reserves has already forced Alcoa to mine lower-grade ore which is, in turn, starting to affect the profits of the business.
Alumina, the Australian partner in the Alcoa business, is exposed to what’s happening, with its share price falling by 20 per cent since February, taking the decline over the past five years to 50 per cent.
Other factors are bearing down on Alumina, including rising power and gas costs for the energy-intensive processes in the three stages of making aluminium from mining bauxite to refining it into alumina and then smelting it into aluminium metal.
But it is the threat of a protracted environmental inquiry into land access at the Huntly and Willowdale mines, south-west of Perth, which have caused Macquarie Bank to downgrade the already depressed shares of Alumina to sell, tipping a fall of another 28 per cent from $1.39 to $1.
Big squeeze
DARK humour award of the month goes to the unnamed author of a story in the Lex column of London’s Financial Times, who noted the surge in the price of orange juice in the US caused by adverse weather in Florida.
Over the past 12 months, orange juice has been the world’s best-performing commodity, up 65 per cent to $US3 a pound.
In the words of Lex: “If the global financial crisis had its big short, this year’s financial trade is more like the big squeeze.”
