China’s problems in property are a difficulty for everyone

As China’s most indebted property developer Evergrande hovers on the brink, the question is where the government will draw the line on support for the firm – and for the financial system.

Markets are nervous but the consensus seems to be that while an example may be made of Evergrande, the damage should be contained there.

But the Financial Times’s Gillian Tett (an insightful chronicler of the 2008 global financial crisis) sees the issue as more fundamental:

“… what is the pillar of faith on which asset values rest? Is it government support? Or is it the independent scrutiny of accounts by investors? Does either pillar work?”

The broader point being that faith in government support can distort asset and liability prices and hide poor decisions over a long time.  

When the public believes that the basis of support is withdrawn, confidence in the system (and associated market values) can change dramatically.  She references the generational stagnation in Japan after the bursting of their financial bubble in 1989 as evidence that the effects can be long-lasting.

Which suggests a profound headache for China’s leaders.  Their growth ambitions require market forces to signal where to use resources by price changes, bankruptcy and market losses. But in order to maintain confidence, the government must also show that it is in control and that these events are containable events on its long planned march to prosperity.  

The rules apply to us too.

So while we can be pleased that our markets did not panic during the pandemic, and relieved that government debt has made good our losses, just reflect on the embedding of the expectation that government can protect everyone – whether from rising power charges or falling house prices, and while solving climate change too. You could say the belief is so strongly entrenched it is hardly worthy of comment.

So if NZ – and the rest of the developed world – are lucky, the economy is stabilised and a sustained tide of economic growth will provide the resources to service the debt and meet expectations for healthcare and other social niceties.  

In the UK, Boris Johnson justified raising taxes on the basis of this bright tomorrow but signs are that he would find it hard to repeat the trick.

So keep an ear open to the possibility of an unpredictable breakage of the social contract having wider repercussions, whether from Evergrande – or something else.

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