On Nov 10, there was a drama in the international financial market. DMSA, a German financial market watchdog, issued a press release stating that China Evergrande Group defaulted on interest payments to international investors and was preparing bankruptcy proceedings.
Evergrande Group is the second-largest real estate developer in China, with total outstanding debt of US$89 billion (2.9 trillion baht). The company's financial problems have been known for years, but no one expected that it would default on international debts as this could tarnish China's economic reputation. Furthermore, it could trigger panic sales of Chinese stocks and bonds much like what happened to Thailand prior to the Asian financial crisis in 1997. Investors hoped that the Chinese government would step in.
Something like that did actually happen. Before the market closed, Evergrande's CEO paid the $148 million interest payment and the company narrowly escaped bankruptcy. He got the cash by selling off his two private jets and taking a loan from China Construction Bank, collateralised with his mansion in Hong Kong. Whether he did all that by his own will, or under some kind of pressure, was anybody's guess.
Evergrande's drama is unlikely to end well, as there is another interest payment of $255.2 million due on Dec 28, which has to be paid by Jan 27. I have no idea how the company or the CEO can come up with the funds. Does he have more luxury items to sell? Even if they can save the company, there is still a total of $8 billion of interest and principal payments that have to be paid next year.
Evergrande is a part of the troubled Chinese real estate sector, which accounts for 30% of its GDP. The boom in China's real estate sector saw an estimated 30 million residential units remain unsold, and a further 100 million sold but unoccupied. Altogether, these units, which are estimated to be worth around $26 trillion, can house 340 million people. Even in a country of 1.4 billion people, where would they find the demand for these units? Widespread bankruptcy in China's real estate sector and among speculative investors is to be expected.
The subprime mortgage crisis of 2008, which involved debts of around $10.5 trillion, caused a global recession which saw the world's GDP growth dip to minus 1.3% in 2009. If a real estate debt crisis of such magnitude were to happen in China, the world economy would not be at peace.
From China, let's cross the Pacific Ocean to the United States. The trouble there is no less severe, but it is not from an overheated real estate sector but inflation. In October, the US inflation rate was at 6.2%, the highest since December 1990. The inflation rate in the United States has been rising quickly since the beginning of the year. The average annual inflation rate for 2021 would be 4.8%. Here is the problem.
A 4.8% inflation rate is far higher than the policy interest rate -- Fed Funds Rate-- of 0.25% and lending rate of 3.25%, which puts the US economy in a negative interest rate position. Negative interest rates mean that savers will save less while borrowers will borrow more, which would further propel inflation and discourage investment.
If the current inflation rate were not bad enough, the expected inflation for 2022 is even worse. An October survey by the Federal Reserve Bank of New York showed that household expectations for inflation over the next 12 months climbed to 5.7% -- the highest rate since the survey began in 2013.
A 5.7% inflation rate and 0.25% Fed Fund Rate do not go well together. However, policymakers hope that the high inflation rate is temporary, owing to global supply chain disruptions from the Covid-19 pandemic and pent-up demand from the opening up of economies.
The Fed is likely to wait until its Jan 25-26 meeting before it makes any move, but it might give certain warnings after its December meeting, especially if November's inflation rate remains unabated.
That said, I hold the opposing view that the high inflation rate is temporary.
Consumers have yet to see real inflation, as producers and wholesalers are still absorbing the rising cost of goods. In Japan, wholesale inflation rose by 8% in October, but consumer inflation was less than 1%. The situation is similar in China. The producer price index rose by 13.5% while the consumer price index increased by just 1.5% in October.
In a few months, we will see producers and wholesalers pass on the higher cost of goods to consumers. That is when the vicious cycle of inflation will begin. Higher-priced goods, particularly food, will trigger demand for higher wages. Higher wages will, in turn, raise the costs of production. Economists term this phenomenon the wage-price spiral.
The only way to stop this spiral is to raise interest rates and push demand down. The Federal Reserve and all central banks in the world -- the Bank of Thailand included -- will have no choice when it comes to dealing with inflation.
Speaking of Thailand, its October consumer inflation rate is 2.38%, which is substantially higher than the Bank of Thailand's policy interest rate of 0.5%. While consumer inflation remains relatively low, the producer price index rose by 6.9% in the same month.
You don't need a PhD in economics to guess what future inflation will be like.
If the risk of a global recession, triggered by the real estate debt crisis in China, and the global rise of inflation and interest rates do become a reality, the prospects that the Thai economy will recover sometime next year would remain gloomy.
First, those factors will hurt our exports and foreign tourist receipts, which account for 71% of GDP. Second, inflation will hurt the lower-income group's purchasing power, which could cause a political uprising.
Third, rising interest rates would create a higher interest burden for all borrowers -- government, businesses, and consumers. And fourth, the shaky world economy, particularly China's, could mean massive capital outflows to developing Western economies.
Don't panic too much though, as this might not happen. China, being a non-market economy, might be able to manage its real estate debt, and global inflation may really be just temporary.
Those are my Christmas wishes, anyway.