This month in crypto: the spectre of debt, reanimated

Remember the October before last?

I hope so, or we have bigger things to worry about.

Well, that October I wrote about the potential collapse of Chinese property giant, Evergrande… and the impact it could have on all financial markets, including crypto.

From that piece:

Of all the many stories that sailed by this month, one of them was so big it threatened to disrupt the entire financial system with its wake.

(Can you tell I watched a lot of boats bobbing about on the med last week?)

And that story was the impending collapse of China’s second biggest property developer, Evergrande.

Three years ago Evergrande became the “most valuable real estate company in the world” and is ranked 122 on the Global Fortune 500, according to Wikipedia.

So what if some property developer in China goes bust? You might think. Why should we care?

Well, because it’s not really so much about the company going bust. It’s about its debt obligations.

You see, Evergrande has around $300 billion of debt…

And this massive pile of debt isn’t just owed to its customers. It isn’t even just owed in China. It’s been packaged up and sold as investment products (bonds) to businesses all over the planet…

Including (allegedly) Tether – the world’s biggest stablecoin and subject of endless controversy, murky dealings and lawsuits – and maybe even the far more reputable stablecoin, USDC. (Source: Coin Telegraph)

So it wasn’t just the regular financial world that got spooked, it was crypto, too.

From Reuters:

Evergrande bondholders also include some of the world's biggest asset managers, according to the latest data published by Morningstar Direct on holdings of U.S. and cross border funds, as well as Asian bond funds.

The debt is held by funds run by asset managers such as UBS, Fidelity, PIMCO as well as emerging markets focused asset manager Ashmore Group, the data showed.

And its shares are also held by various funds and ETFs around the world.

Again, from Reuters:

"On the equities side, various Vanguard funds held a combined $40 million or so worth of shares as of August, Refinitiv Eikon, data showed, while BlackRock held at least $13 million across its iShare MSCI emerging market ETFs."

So when the news surfaced Evergrande was about to default on its $300 billion of debt, its share price tanked and it set off a shockwave of panic around the financial world.

Reuters, again:

Shares in Evergrande, which has been scrambling to raise funds to pay its many lenders, suppliers and investors, closed down 10.2% at HK$2.28 on Monday, after earlier plummeting 19% to its weakest level since May 2010.

Regulators have warned that its $305 billion of liabilities could spark broader risks to China's financial system if its debts are not stabilised.

World shares skidded and the dollar firmed as investors fretted about the spillover risk to the global economy. U.S. stocks were sharply lower, with the S&P 500 down nearly 2%.

The financial world held its breath as the 23^rdof September – the deadline day for Evergrande’s payment – approached… and went by.

“‘Eerie silence’ as Evergrande misses payment deadline”, wrote the Guardian.

But for some reason, no one really seemed to care. By this point the deadline to increase the US debt ceiling was taking centre stage.

“Fed official warns of ‘extreme’ market reaction unless debt ceiling raised”, wrote the Financial Times on the 28^th of September.

(The debt ceiling did get temporarily raised this week, like it always was going to.)

And the whole Evergrande fiasco just sort of faded into the background.

But nothing actually changed. And now two weeks on, things are coming to a head.

On the 3^rd of October, Evergrande shares stopped trading.

From the New York Times:

Shares of China Evergrande were halted on Hong Kong’s stock exchange on Monday pending a deal, as doubts swirled over whether the struggling property giant would be able to meet its immense financial obligations.

Evergrande said in a filing that its shares were halted ahead of an announcement about a “major transaction.” It gave no additional details.

The real estate developer — once China’s most prolific — has been under close watch by foreign investors and local regulators after it missed two important interest payments on U.S. dollar bonds. The missed payments may not necessarily trigger a default because they each have a 30-day grace period before the missing payment would be considered a default.

The big question now is will Evergrande miss that 30-day grace period deadline? Which I calculate expires on the 30^th of October. Just in time for Halloween.

And if it does, what will happen?

Well, it looks like we’re going to find out.

From the Wall Street Journal on the 8^th of October:

Advisers to China Evergrande Group’s international bondholders have made little progress in their efforts to engage with the embattled property developer, as the clock ticks toward a likely default.

The Chinese real-estate giant skipped interest payments on $1 billion in U.S. dollar bonds on Sept. 23, and has a 30-day grace period before its bondholders can call a default. Evergrande also didn’t pay the coupon on another set of dollar bonds last week. The 25-year-old company is China’s largest issuer of junk bonds, with more than $19 billion in dollar debt outstanding.

It’s also worth noting that Evergrande is just the most prominent in a long line of Chinese property developers that are struggling.

From the Financial Times on the 8^th of October:

"Almost half of China’s 30 biggest developers were in breach of at least one of Beijing’s recently introduced rules on property sector leverage, according to a Financial Times analysis of the latest available data."

And, as the Economist writes, if China’s property sector goes down, it’s going to take everything down along with it:

The property market is probably the single largest driver of [China’s] economy. Urban Chinese have flocked to it as a haven. House prices have soared over the past 15 years, often by more than 10% a year in large cities. Yet developers have borrowed huge amounts in the process. The industry’s total debt is about 18.4trn yuan ($2.8trn, equivalent to 18% of gdp), according to Morgan Stanley, a bank. Housing costs, relative to incomes, now make large Chinese cities some of the least affordable places in the world.

These trends have collided with officials’ goals of reducing corporate indebtedness and inequality, which lie at the heart of Mr Xi’s mission to bring “common prosperity” to China. The campaign has already brought down several large real-estate companies as regulators have tightened their access to credit. The latest is Evergrande, a developer with about $300bn in liabilities that has started to miss payments on dollar bonds. (As The Economist went to press Evergrande seemed to have missed another offshore-bond payment, due on September 29th.) The fear for officials is not just that the unwinding of the group will unleash systemic financial risks. If the property sector were to tip into a correction, everything from local-government and household finances to the country’s growth model would be imperilled.

So, yeah… it’s going to be an interesting month in finance, that’s for sure.

And as I’m sure you know, what happens in the wider world of finance directly affects the world of crypto.

Well, over the last two years, Evergrande continued to flounder, along with the rest of the Chinese property sector. And then this month, it finally threw in the towel and filed for bankruptcy (in New York).

From Reuters:

Embattled developer China Evergrande Group filed for U.S. bankruptcy protection as part of one of the world's biggest debt restructurings, as anxiety grows over China's worsening property crisis and its impact on the weakening economy.

China unexpectedly lowered several key interest rates earlier this week in a bid to shore up struggling activity and is expected to cut prime loan rates on Monday, but analysts say moves so far have been too little, too late, with much more forceful measures needed to stem the economy's downward spiral.

You would hope that over the last two years, the big asset managers have managed to shield themselves from this slow-motion collapse. But I guess that’s easier said than done.

Again, from Reuters:

Domino effect?

The property crisis has also fanned worries about contagion risks to the financial system, which could have a destabilising impact on an economy already weakened by tepid domestic and foreign demand, faltering factory activity and rising unemployment.

A major Chinese asset manager has missed repayment obligations on some investment products and warned of a liquidity crisis, while Country Garden, the country's No.1 private developer, has become the latest to flag a stifling cash crunch.

What does all this have to do with crypto?

As we see time and time again, crypto takes its cues from the wider financial system. It bills itself as an alternative to the traditional financial system, but it just can’t break ties with it.

And since the corona-crisis especially, crypto just acts like a riskier, more volatile version of the traditional stock market.

So, if all this Evergrande stuff spooks a few traditional finance companies, it’ll likely cause an entire stampede in crypto.

Is that the reason Bitcoin and Ethereum are down by double digits this week? Probably not. You never actually know why crypto prices do anything. But it could easily be a contributing factor.

And, in related news, it emerged this month that even though crypto is banned in China, the world’s biggest crypto exchange’s biggest market is… China.

From The Wall Street Journal:

Binance, the world’s largest crypto exchange, was supposed to leave China behind when the country made cryptocurrency trading illegal in 2021.

Almost two years later, users traded $90 billion of cryptocurrency-related assets in China in a single month, according to internal figures viewed by The Wall Street Journal and current and former employees. The transactions made China Binance’s biggest market by far, accounting for 20% of volume worldwide, excluding trades made by a subset of very large traders.

China’s importance for Binance is openly discussed internally, according to the current and former employees. And despite the ban, the exchange’s investigations team works closely with Chinese law enforcement to detect potential criminal activity among the more than 900,000 active users in the country, according to some of the current and former employees.

So, if China really is having a Lehman moment, it’s likely to impact massively on crypto.

And with that in mind, for the rest of your Sunday afternoon reading, I’d recommend this longform article by the Wall Street Journal: “China’s 40-Year Boom Is Over. What Comes Next?” It’s very interesting.

And, if you don’t have a Wall Steet Journal Subscription, here’s a good excerpt:

“We’re witnessing a gearshift in what has been the most dramatic trajectory in economic history,” said Adam Tooze, a Columbia University history professor who specializes in economic crises.

What will the future look like? The International Monetary Fund puts China’s GDP growth at below 4% in the coming years, less than half of its tally for most of the past four decades. Capital Economics, a London-based research firm, figures China’s trend growth has slowed to 3% from 5% in 2019, and will fall to around 2% in 2030.

At those rates, China would fail to meet the objective set by President Xi Jinping in 2020 of doubling the economy’s size by 2035. That would make it harder for China to graduate from the ranks of middle-income emerging markets and could mean that China never overtakes the U.S. as the world’s largest economy, its longstanding ambition.

Many previous predictions of China’s economic undoing have missed the mark. China’s burgeoning electric-vehicle and renewable energy industries are reminders of its capacity to dominate markets. Tensions with the U.S. could galvanize China to accelerate innovations in technologies such as artificial intelligence and semiconductors, unlocking new avenues of growth. And Beijing still has levers to pull to stimulate growth if it chooses, such as by expanding fiscal spending.

Even so, economists widely believe that China has entered a more challenging period, in which previous methods of boosting growth yield diminishing returns.

In other crypto news

PayPal has issued an Ethereum-based stablecoin, created by Paxos (the same company that made Binance’s BUSD stablecoin). But people are worried PayPal can choose to block, freeze and wipe user accounts. Although this article on Binance points out USDC and USDT (Tether) have very similar controls over their stablecoins.

The SEC is – unsurprisingly – trying to appeal the Ripple decision.

The Federal Reserve is cracking down on crypto friendly banks.

The first Bitcoin Spot ETF has launched in the EU. As I said in last month’s premium issue, with the EU’s MiCA legislation now up and running, you can expect a lot of legitimate crypto businesses to set up shop there.

Okay, that’s all for today.

Thanks for reading.

Harry

Full disclosure: At time of writing, I held the following cryptos: Ethereum, IOTA, Radix, Mina Protocol, Aleph Zero.

Disclaimer: This content does not constitute financial advice, tax advice or legal advice. Your money and how you choose to spend it is your responsibility. Nothing that appears here should be construed as investment advice or recommendations to buy or sell any securities, cryptos or investments. coin confidential does not offer investment advice. We merely provide information. Crypto investing is highly risky, and you could lose 100% of the money you put in. You should not base any investment decision solely on information we publish. We believe all information we publish to be accurate, but we cannot guarantee it. Always do your own research before making any decisions about your money. See the full disclaimer for more.