Evergrande Crisis Contagion Plays Into Gold Price

How China’s Evergrande crisis could drive gold higher

Bullion.Directory precious metals analysis 15 November, 2021
By Peter Reagan
Financial Market Strategist at Birch Gold Group

Right now, the nation’s largest real estate developer has officially defaulted on its debt. With over $300 billion in liabilities, Evergrande is the world’s most indebted property developer. The situation has already caused some localized turmoil in China.

A number of other developers are either in default or desperately struggling to postpone their debt payments, and more than half of all China’s property developers’ bonds are junk-rated, according to S&P.

Sieron doesn’t expect to see a repeat of 2007-2009 over Evergrande alone, based on the nature of the company. He doesn’t take this to be China’s “Lehman Brothers moment.” That doesn’t make the Evergrande case any less important, or indeed, any less threatening to the global economy.

China’s economic expansion and, more specifically, its private wealth is very closely tied to the real estate sector. Real estate is nearly 30% of the nation’s GDP. And, like Evergrande itself, the sector is unhealthy. Daniel Lacalle notes that China pursued growth at all costs, which gave way to “ghost cities, unused infrastructure, and wild construction.”

What’s going on here? The Carter Center’s Ruka Wang explains the backstory behind China’s overdevelopment:

China’s post-1978 development model has primarily relied on two growth drivers: (1) fixed asset investment mostly in infrastructure and (2) low-wage manufacturing for exports. China’s infrastructure investment is the highest in the world. According to a 2016 McKinsey report, China’s rate of infrastructure investment(about 8.6% of its $11 trillion GDP) is nearly twice as much as India, the next largest spender, and over three times as much as the US and Canada.

In the short-term, investing in infrastructure like this produces economic benefits. Workers from a hundred different specialty fields, from architects to painters, are paid to work. Mountains of steel, concrete, glass and copper are transformed into girders, buildings, windows and wiring. The finished product requires an unthinkable number of miscellaneous manufactured goods (light switches, carpet, tiles, pipes, doorknobs, window blinds) all available from local factories. A company or a nation with money to burn can burn it right at home, and heat up the economy a bit.

The problem with building uninhabited cities, untrafficked superhighways and empty airports is fairly simple: They cost money to create, but don’t offer any return on the investment. In other words, once that money is burned up, the heat is gone.

Unfortunately, the majority of China’s property development and infrastructure spending have failed to pay back their costs. Wang quotes a University of Oxford study that found a mere 28%, about a quarter, of China’s infrastructure projects have been “genuinely economically productive.”

That same 2016 study mentioned above concluded:

We predict that, unless China shifts to a lower level of higher-quality infrastructure investments, the country is headed for an infrastructure-led national financial and economic crisis, which is likely also to be a crisis for the international economy. China’s infrastructure investment model is not one to follow for other countries but one to avoid. [emphasis added]

Experts estimate that a 20% fall in real estate activity could translate to a 5%-10% reduction of China’s GDP, which, lest we forget, is the world’s second-largest.

Given China’s clout on the global stage, it will affect both imports and exports. We tend to think of China as an exporter only, which doesn’t match facts. China imports half a billion dollars of electronics equipment alone each year, and spends about $2 trillion annually on imports.

Sieron expects that any initial rush to safety will pick the U.S. dollar over of gold (so long as the former holds up.) Should the greenback’s recent inflation surge continue, or should America’s economy begin to feel the effects of China’s contraction, gold will take its historic crown as the safe haven of choice for those seeking shelter from an economic crisis.

This article was originally published here

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