China’s crypto ban (again) and Chinese policy changes driving the Evergrande crisis are this week’s focus. When the world’s second largest economy bans an asset class and the largest token (bitcoin) only drops ~5%, does that not seem like a source of strength? Yes, the volatility is unpleasant, but that’s why The Dispatch believes appropriate position size and a long-term view are essential tools for this volatile asset class.
In traditional markets, most investors were blissfully unaware of Chinese property company Evergrande until worries about the company’s debt load led to a global stock selloff this week. The Dispatch is quite familiar with Evergrande from the past life and is most focused on possible changes to accommodative real estate policy in China. Such a change could have material long term impact on many commodities. It’s probably wise to avoid commodities that rely on Chinese investment for substantial demand as we might be seeing a notable change in Chinese real estate (RE) policy.
Dispatch #31 discussion items on 24th September 2021 are listed below.
- Evergrande, China RE policy and commodities
- China “bans” cryptocurrencies again!
Evergrande and Chinese policy change
Worries about contagion from an Evergrande default led to a global equity selloff earlier this week. Evergrande is a company that The Dispatch knew well in the past life as an emerging markets investor. The company’s debt levels have been steadily rising for many years, but new policies from Beijing led to the current cashflow problems. The new policy, widely called Three Red Lines, restricted companies from issuing new debt based on financial thresholds, as shown below. Needless to say, Evergrande was in the red on all three of the
Three Red Lines
Source: UBS Asset Management
This is a notable change from many decades of official policy that supported higher property price and real estate companies. For most financial market observers, what’s happening today is purely a capital misallocation issue. However, the Dispatch takes the view that there’s a larger socio-economic driver behind the Chinese Communist Party’s (CCP) policy changes. This story in the Guardian provides a glimpse into the delicate balance between property affordability, gender imbalance, falling marriage rates/birth rates and male eligibility to name a few factors. Underlying all this is potential popular discontent with the CCP, which drives most party decisions.
If you do want to peel back the Evergrande onion, it’s crucial to understand how the RE sector fits within the wider Chinese economy and what Beijing’s policy changes aimed to achieve. This essay What Does Evergrande Meltdown Mean for China? by Beijing-based Professor Michael Pettis provides exactly that. The paragraph below from his essay is instructive of the delicate balance facing Beijing policy makers.
Source: Michael Pettis
Property affordability is worst in the world
At a sector level, this Tweet thread by the founder of Exante Data explains the excesses in the Chinese real estate market. One of those tweets shown below illustrates how property is outrageously unaffordable in China relative to incomes.
Source: Exante Data
Chinese real estate firms have excess debt levels
If you’d like to dig deeper into the capital misallocation of Evergrande and contagion within China RE companies, this is an excellent Tweet thread. The chart below illustrates the dominance of Chinese RE companies in the list of the world’s largest interest payers.
Source: Journalist at The Economist via Twitter
Chinese policy making has seen a structural break
To conclude, when we combine Beijing’s 2021 action against the large tech firms, demolishing the after-school education sector, crypto ban (see next story) and now Evergrade/ RE, it’s best to assume that there’s a notable change underway in how the Central Government is driving growth. It’s different to the growth-at -all-cost model of the past several decades.
These tweet from Prof. Pettis on September 23rd speculates how the Evergrande situation might resolve.
Source: Michael Pettis via Twitter
Implications for commodity demand
The Dispatch is focused on the implications for commodity sectors as there are global macro drivers that suggests a tight demand/supply environment for many commodities. The changes in China point to avoiding commodities that are heavily dependent on Chinese investment for end demand. From that macro view, the seaborne iron ore and coking coal sectors are two that might be impacted by the potential changes to Chinese RE.
China crypto ban… again!
That’s right, the country is “banning” crypto activity again. This time 10 government agencies are coordinating the action. China has not banned ownership of crypto assets but it has banned any trading in crypto tokens. This Coindesk article notes that this week’s announced is a notable tightening of regulations. It would be wise to assume that we’ll see high profile conviction/arrests of crypto personalities in the coming months to drive home these tighter regulations. Such an action would be no different that the SEC’s threat to sue Coinbase over the Coinbase Lend cypto interest product. It’s high profile signalling to the industry.
We have seen this before
Nevertheless, The Dispatch would be remiss if it didn’t point out that we’ve seen “crypto ban” statements from China before. The stories below, that go back to 2013, are reminders.
Source: via Twitter
The chart below from Grayscale also shows how bitcoin has performed since earlier “China bans”.
Source: Grayscale Market Bytes email 9/24/2021
As a long-term investor in the emerging digital asset space, The Dispatch is less troubled by the regular announcements by China. Governments will NOT easily give up their monopoly to issue an effective currency. Genuinely decentralized, trusted, scarce private digital currencies will challenge the effectiveness of government money. As a result, we should continue to expect policy measures against some or all of digital currencies. Domicile your investment activity in a jurisdiction with robust private property rights/legal system to minimize these regulatory measures. In The Dispatch’s biased view, the US still offers the best regulatory regime in spite of all the debate surrounding regulation.
Evidence of resilience?
Furthermore, if a young asset like bitcoin only drops ~5% after the world’s second largest economy bans the asset class, doesn’t it further reinforce the resiliency of that asset? We often hear that China is cracking down on crypto because they want the Digital Yuan to flourish. With these unilateral announcements/decisions by China, no one in their right mind should store wealth in the Digital Yuan.
Stay safe, enjoy the cooler days and do reach out if you have any questions or comments about the material in this Dispatch.
Asi
Important Disclosures
| This is not an offer or solicitation for the purchase or sale of any security or asset. While the information presented herein is believed to be reliable, no representation or warranty is made concerning its accuracy. The views expressed are those of RockDen Advisors LLC and are subject to change at any time based on market and other conditions. Past performance may not be indicative of future results. |