“Stability leads to instability. The more stable things become and the longer things are stable, the more unstable they will be when the crisis hits.” – Hyman Minsky
The situation in China went from bad to worse in the past week, with the collapse of Evergrande leading to early signs of significant contagion. By most measures, Evergrande’s collapse is a more meaningful event than Lehman’s implosion, which is why the two words are so closely associated with each other on social media. Whether Evergrande is a catalyst for the next great financial crisis remains to be seen, although the early signs are worrisome.
Days like today are why I started Doomberg. Judging by the volume of inbound questions I’m getting about whether I think this is the start of The Big One, people recognize this event could be different. Let’s consider both sides of the argument.
The doom argument rests on the criticality of real estate to the Chinese economy. In particular, the level of malinvestment in that sector since the last global financial crisis is staggering. If you believe Minsky moments are inevitable, you’d be hard pressed to find a better fact set than what’s coming out of China these days. It is difficult to imagine how the collapse of Evergrande doesn’t cause a rolling crisis of confidence across all the other property developers in China, which in turn almost certainly bankrupts the entire Chinese banking system. That’s not hyperbole, that’s simple arithmetic. China’s economy – much like ours, only more so – is a giant Ponzi scheme that rests on a foundation of bloated confidence. That confidence is deeply shaken today.
Having said that, the counter argument is simple. Xi won’t allow the entire economy to collapse, and the major central banks will intervene to stem the bleeding as well. That argument has been the correct one since Alan Greenspan was Fed chair. If you did nothing but wait during the global financial crisis, you were rewarded handsomely - eventually. If you did nothing but wait when Covid-19 crushed markets, you were rewarded handsomely - eventually. We all know what the chart of the S&P 500 looks like when you zoom out far enough. Stocks only go up and whatnot, and assuming you have a long enough time horizon to make it to eventually, you’ll do just fine.
A third possibility occurred to me after reading a provocative piece that hit my inbox last night. In Grant Williams’ latest edition of Things That Make You Go Hmmm… (available by subscription), Grant wrote compellingly about what’s going on in China today. Perhaps Xi is proactively creating this crisis to consolidate power at home? What if Xi is willing to crash his economy so he can gain a tighter, more permanent grip on the power to rebuild it in his image? A review of Xi’s activity over the last 12 months amounts to one helluva Stalin impression.
It is an interesting thought. I have long assumed a globally coordinated response would be required to keep kicking the Ponzi can down the road. If Xi is truly cutting his own path now, is there anything Western central banks can do about it? Are they capable of even recognizing this possibility, or are they too busy trading their personal accounts to formulate an effective response?
I don’t know what’s going to happen. Nobody does. But here’s one stock that I’m watching closely for signs: Tesla. We don’t write much about Tesla in this newsletter, and for good reason. The toxicity of that topic is bewildering and there’s plenty of well-informed thinkers from whom you can get your fill of opinions about Elon Musk. But if there’s one company that simultaneously serves as a metaphor for today’s ludicrous valuations, cult-like following, and heavy dependence on the ongoing blessings of Xi’s China, it is Tesla. If China truly falls apart, Tesla won’t be far behind. As I write this piece, Tesla is fetching a market cap of more than $700 billion. If today is the beginning of The Big One, I’d expect to see Tesla’s market cap sliced in half or more.
Until then, I’m heading back into my bunker.
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