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China, Evergrande and The Boom & Bust Cycles of Capitalism

The recent headlines in the markets are all about China's "Evergrande" which may require a name change before the dust finally settles. China's quasi capitalist front - the business class - which is under the umbrella of Communism is under fire on many fronts. Let's discuss the economic front first. Evergrande - you may not have heard of the company until now - is China's largest property developer and has been a company at the forefront of China's economic boom and phenomenal new city development and expansion. As can be the case in an economy that has been booming and expanding for decades, it is easy for companies to lose sight that "booms" always come to an end. The economic cycles in Capitalist societies are inevitable, in spite of trillions in government "funding" intervention in the last decade. China is not a capitalist society - at least not culturally - and the interesting juxta-positon between capitalism and communism under one roof is playing itself out now with "Communism" asserting itself in ways that those who have heavily invested in china are now discovering to their detriment.

Evergande's booming business was fuelled by increasing debt and leverage. As can happen, that debt to debt servicing ratio was not properly managed and the banks - yet again - failed in their fiscal due dilligence and evaluation of the company. The US equivalent often cited in the media is "Lehman Borthers". The bottom line is that "Evergrande" is teetering and on the cusp of failure, unable to service its debt with no immediate convincing plan to lower its $300 billion debt mountain. It missed it's interest payment to bond holders yesterday - thursday September 23rd - and now has a 30 day grace period to make good on this or officially be in default. The writing is on the wall. It has effectively lost the little negotiation power it may have had. It's unlikely - not impossible - that the company will survive in its current "Evergrande" form. Will the chinese state intervene? Given the millions of livelihoods at stake and economic repercussions for the region, there is a high likelihood the government will intervene in some way. In wake of China's clamping down on "businesses" that have grown too big and too powerful for the State's liking and its emphasis on the welfare of the people, we see a strong possibility that state financial aid will come, but with caveats or demands that the company be broken into several companies and assets sold off to pay down bondholder and retail buyer debt.

As we have already mentioned, we believe it is unlikely that "Evergrande" will survive in its current form.

Capitalist systems are no strangers to boom and bust scenarios. They are built-in to the capitalist system and the expansionary and contracting fiscal lending or credit availability cycles which in turn are built on a complex architecture of leverage. When large businesses fail, the knock-on effects cascade through the financial markets with an inevitable contraction in credit availability and liquidity calls that require "cash to be raised" which in turn create "selling pressures" in the stock, bond and crypto currency markets. The digital or crypro currency markets - which are large and liquid and open 24/7 - will as result typically be most impacted, followed by the stock and bond markets.

We live in a complex financial architecture with cascading impacts when large institutions and businesses fail which now more often than not, necessitate some government intervention.

If this seems highly complex and difficult to understand, it is because it is. For most people, this is arcane and incomprehensible. Our global financial system is highly leveraged and inter-connected. In the case of Evergrande, most of the fallout or cascading effects will be in the Asia region. US and European banks have relatively minor exposure to Evergrande.

In a complex financial world where debt is tied to significant leverage, negative events have ramifications that can cascade, iimpacting businesses and potentially hundreds of millions of people. If you wonder why governments are more involved in the financial markets than ever before, it is because those ramifications can destabilize entire economies, large sectors of their populations and the government itself. In a world where US debt is reaching to numbers that even the most creative imaginations cannot grasp, any rise in interest rates has magnitudes of impact on servicing that debt. That is of course a significant geo-political matter for the US in its role as the global reserve currency. And finally, as if the latter were not enough,depressions and difficult financial markets are just not good for politics.

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Walnut Creek, CA 94596
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