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Opinion

China's Lehman Brothers moment

Spate of late-year defaults suggests bears might be right after all

| China
It is not anti-China to believe the laws of gravity apply to President Xi's nation.   © Reuters

William Pesek is an award-winning Tokyo-based journalist and author of "Japanization: What the World Can Learn from Japan's Lost Decades."

Investors betting on a Chinese debt crash these past 10 years have little to show for their skepticism about the world's No. 2 economy. Recent turmoil in credit markets makes you wonder if the bears might soon have their day.

Defaults by state-owned companies as 2020 staggers to a close are making headlines at the worst possible moment. They come as lame-duck U.S. President Donald Trump threatens new sanctions on his way out the door, and as HSBC Holdings confirms what the bulls have long known: China Inc.'s moment has arrived.

The interplay between these moving parts is tantalizing. Since 2017, Trump threw every impediment he could think of at Xi Jinping's booming economy. A new HSBC report shows the extent of his failure.

This survey of 10,400 companies in 39 countries finds China is now the No. 1 foreign market for Asia-Pacific companies. China is the top trading partner for 29% of them, versus America's 28%, and wow will that sting as the Trump era ends. Multinationals are not decoupling from China; they are finding ways to disperse production around its orbit. The pandemic, it turns out, is accelerating shifts that predate Trump.

Yet the turmoil of 2020, some bearing Trump's fingerprints, is also surfacing cracks in China's foundation that predate his event-rich tenure. The spate of late-year defaults owes partly to Trump's trade war and aggressive curbs on state-owned enterprises. What Trump, and COVID-19, really did was expose a Communist Party with preexisting conditions festering for more than a decade.

This gets us back to the China bears, who date back a decade. In 2010, for example, short-seller Jim Chanos of Kynikos Associates famously claimed Beijing was on a "treadmill to hell." Since then, naysayers like Kyle Bass of Hayman Capital have fruitlessly bet against the yuan. Bass exited his four-year crusade in the first half of 2019.

The search here is for China's "Lehman moment." It is not anti-China to believe the laws of gravity apply to President Xi's nation. Before Japan's 1990 reckoning, few thought Asia's then-biggest economy could implode. Similar denial preceded Mexico's crash in 1994, Southeast Asia's in 1997, Russia's in 1998, America's in 2008, Europe's in 2010, emerging markets hitting a wall in 2013 or today's pandemic bringing back the 1930s.

Every industrializing nation, without fail, eventually stumbles amid excess credit and debt. Can China beat the odds? Anything is possible. But faith in Xi's team, smart as it is, owes much to the myth of Chinese invulnerability dating back to the Lehman period. China, then in the hands of President Hu Jintao, steered masterfully around the subprime reckoning. Has Beijing, though, sown the seeds of a subprime financial system unready for global prime-time?

Most global investors had never heard of Yongcheng Coal and Electricity Holding Group until it missed a bond payment last month. Since then, its billions of dollars of outstanding bonds have literally become a canary in China's proverbial coal mine. Defaults by chipmaker Tsinghua Unigroup and Huachen Automotive Group added fuel to an already raging debt market sell-off. That increased scrutiny of the health of China Evergrande Group, the world's most indebted developer which owes creditors more than $120 billion. And so on, and so on.

Tsinghua Unigroup's logo is attached on a door of its research center in Beijing: defaults by Tsinghua Unigroup and others added fuel to an already raging debt market sell-off.   © Reuters

The fun may continue if Trump adds chipmaking behemoth Semiconductor Manufacturing International Corp., better known as SMIC, to his China blacklist. Or, for that matter, China National Offshore Oil Corp., or CNOOC, and other mainland giants sure to share their stumbles broadly. Here, Trump's policies are more of an accelerant than an underlying cause. China's macro story is a hypnotic one that will keep U.S. President-elect Joe Biden on his toes. Xi's Made in China 2025 plan, and moves to create a Silicon Valley East on his southeastern seaboard are game-changers. His Belt and Road juggernaut is making headlines around the globe.

Yet recent defaults remind us that China's microeconomic development is lagging behind these grand designs. Since 2008, Xi's party relied more on debt and credit than structural upgrades. And papering over cracks with public money.

In 2012, Xi grabbed the reins promising to increase transparency and let market forces play a "decisive" role in policymaking. That was put to the test in 2015, when Shanghai stocks collapsed and Kaisa Group Holdings became the first Chinese property developer to default on dollar bonds. His government did not like the fallout, though, and got back on the stimulate-at-all-costs treadmill. This made the deleveraging balancing act Xi now confronts harder than it needed to be.

The clampdowns getting the most attention involve tech companies on the run from regulators. Case in point: Jack Ma's now shelved Ant Group initial public offering, which would have been history's biggest. But the clampdowns that really matter are on state companies leveraged to the hilt and warping an economy moving to center stage.

The curtain call highlighted by HSBC leaves little doubt where the economic inertia is heading. Yet whether China Inc. is ready to lead -- and avoid a Lehman moment -- is an open question. If Xi's team does not accelerate efforts to repair the micro economy, the China bears may love the answer.

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