The looming bankruptcy of a Chinese property developer might not seem to amount to a hill of soybeans, but what happens to Evergrande Group, and all that could follow, might mean a heck of a lot to all Canadian crop and livestock prices.
Regardless of low world supplies of many crops, including canola, a bad fate for Evergrande could see world commodity demand suddenly shrink, along with commodity prices.
“The Next Real Estate Crisis Could Come from China,” noted one Oct. 1 headline. That’s scary, because if we throw our minds back to 2007, we might recall the financial crisis that erupted after the United States subprime mortgage market went into freefall and all sorts of banks, investment funds, insurance companies and pension plans around the world faced ruin from what had seemed an obscure part of the market.
Evergrande is the biggest homebuilder in China, the world’s most growing market. Right now, it is building homes in 240 cities in China, with 1,300 projects on the go. It is a colossus.
It is also colossally indebted, with US$310 billion owed. In 2020, it earned $81 billion, so the repayment math ain’t great. It has already failed to pay interest on one of its bonds, with only a few weeks of grace in which to avoid bankruptcy.
The Chinese government might step in, but it might not. There don’t appear to be any good resolutions here. China’s economy has been slowing for years and creating more zombie companies isn’t likely to stop it from slowing further.
How does that feed into commodity and agriculture demand?
It’s a potential killer of general demand — around the world.
One of China’s main economic engines has been homebuilding, which consumes much more of the country’s capital investment than countries like Canada. The industry employs millions, and the personal wealth of tens of millions of Chinese homeowners depends upon the health of its housing market.
Companies like Evergrande have fuelled themselves with debt while building millions of homes that stand empty, leaving China with an array of ghost cities and neighbourhoods. If Evergrande goes bust the whole industry, which more and more seems like a house of cards, could collapse.
That would be bad for demand for steel, coal, copper and other industrial commodities used in construction. If property developers like Evergrande go broke, that would be bad for Chinese banks and investors. If those financial institutions and investors slide into trouble, or just get scared, they could suck in all their credit and capital from all sectors and leave the Chinese economy gasping for air.
That sort of thing tends to cause a financial crisis, and those have tended to spread worldwide since the late 1990s, because investors around the world, including everybody’s pension plans, are often knee-deep in dodgy foreign “assets” like Evergrande.
The domino effect of one bad debt causing many others to fail is known as “contagion.” And that tends to see even surviving companies slash investment, cut jobs and become very conservative. That’s bad for commodity demand.
And millions of people lose their jobs, which tends to lead to much less consumer consumption of goods, services and even food.
All of a sudden, those tight commodity fundamentals begin to loosen and the bull market can turn into a bear.
Will that happen with Evergrande? Who knows? The Asian financial crisis of 1997 didn’t cause a worldwide commodity market slump and economic collapse. Nor did the 1987 black Tuesday stock market meltdown. But the 2007 Lehman moment did. Take your pick of historical precedents.
Lots of people are still calling for a renewed commodity bull market, so it seems silly to panic. But it’s worth keeping an eye on Evergrande.
It’s the sort of contained risk that can become uncontained pretty fast and wipe away all those juicy ag commodity prices that are making the future look so nice right now.