Evergrande's fallout casts a shadow over the U.S. economy
News stories about China’s deteriorating economy have multiplied in recent months.
Industrial production in China rose 3.7% annually in July, down from 4.4% the month prior, and below forecasts of a 4.4% rise for the month.
At the same time, retail sales increased 2.5% year-on-year in July, slowing from 3.1% in June and far below estimates of 4.5% growth.
Exports out of the country slipped 14.5% to a five-month low of $281.75 billion in July, a steeper drop than the 12.5% fall predicted by the market.
As for youth unemployment, Beijing abruptly paused its July release. However, in June, it was reported that more than one in five people aged 16-24 were without jobs.
If the latest economic releases weren’t bad enough, on August 17, the country’s second-largest property developed by Evergrande Group filed for Chapter 15 bankruptcy protection in a U.S. court.
What's up with Evergrande?
Last month, when Evergrande finally released financial data for the prior two years, markets were taken aback. The report revealed net losses of $66 billion for 2021 and $15 billion for 2022, for a total two-year loss of $81 billion.
To put that loss in perspective, it’s greater than the GDP of Croatia and larger than Microsoft’s entire 2022 profits.
In other words, when a massive Chinese property developer is in trouble, the markets notice.
Many problems driving trouble in China’s property market come from its growing and unregulated shadow banking sector. These banks, known as trust firms, operate in a grey area that permits them to skirt rules that govern conventional banking.
Many property developers in the country source funding from shadow banks when they cannot secure capital from a traditional institution. Incredibly, China’s shadow banks are now a $3 trillion industry.
That’s roughly equivalent to Britain’s entire economy, the sixth largest in the world.
News of Evergrande’s declaration sparked fears of contagion.
The fear isn’t unfounded. In terms of size, China’s economy is second only to the U.S. As for real estate, it accounts for as much as 30% of its entire gross domestic product.
It wasn’t always this way. China’s share of global GDP has exploded in recent years. In 1980, its share of global GDP was 2.3%. By 2022, it had climbed to 18.5%.
Put another way, China’s economy is now eight times the weight it represented just over four decades ago.
American collateral damage
It’s not just Chinese property. Manufacturing and construction companies are struggling. U.S. businesses with firm ties to China say they’re feeling the effects.
In light of China's woes, many U.S. companies have trimmed outlooks for the remainder of the year. Citigroup, which experienced a 36% annual drop in net income last quarter, stated that China’s slowing growth was its “biggest disappointment.”
And It’s not only financials.
American biotechnology company Thermo Fisher Scientific cited China’s decelerating growth as the catalyst for cutting its end-of-year forecasts.
The diversified American conglomerate Danaher Corporation similarly pulled back its annual sales growth forecast. CEO Rainer Blair attributed the cut to mediocre growth overseas, with China accounting for roughly 13% of the company’s total revenue.
Not only that, Rainer said orders from China in the second quarter dropped a monumental 40%.
Michigan-based Dow, one of the three largest chemical producers in the world, experienced an 80% drop in net income during Q2.
Referring to China, Dow's chief financial officer, Howard Ungerleider, said, “The anticipated economic rebound following the end of zero-COVID restrictions has yet to fully materialize."
Another American giant, Procter & Gamble, witnessed a modest 1% drop in volumes last quarter, driven by weaker demand in the Greater China Region.
Even the broad market is feeling the impact.
Following the economic releases out of China, U.S. markets quickly sank on August 15. The Dow Jones industrial average fell 1%, and the Nasdaq composite tumbled 1.1%.
The S&P 500 fared even worse, dropping 1.2%, one of its poorest performing days since the spring. And U.S. crude oil fell by $1.52 per barrel to $80.99.
Does Evergrande foreshadow a U.S. housing crisis?
Despite the concerns, China is far from the only country with a troubled property market.
During the first quarter of 2023, multifamily home sales in the United States experienced their largest decline since the great depression.
Many mortgages backing these properties are coming due over the next year and a half. “Absent a clear path to replacing these loans — which the bank, bond, and insurance markets do not have the capacity nor appetite to accommodate — prices can be expected to reset…” said Julian Salisury, chief investment officer for Goldman Sachs
Historically high inflation and elevated interest rates are suppressing domestic demand. And increasingly stringent lending requirements are further dampening housing activity in the U.S.
On the commercial side, it looks even worse. Buildings in downtown U.S. metropolises remain barren. Even in New York City, office building values have reportedly lost $76 billion from their most recent sales.
Evergrande’s widely publicized declaration of bankruptcy will continue to cast a shadow on global markets, but the extent of the ripple effect remains to be seen.
Even though China often maintains an isolationist stance, its influence on worldwide economic dynamics cannot be ignored.
This raises the question: Does China's crisis hint at an impending property downturn in the U.S.?