Interview

«China Always Finds Some Way to Push These Things Under the Rug»

Anne Stevenson-Yang, China expert and founder of J Capital Research, comments on the crisis surrounding the teetering real estate colossus Evergrande, recent regulatory interventions against tech giants such as Alibaba and Tencent, and the overall economic state of the People's Republic.

Christoph Gisiger
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The foundations of China's real estate sector are shaking. Evergrande, the second-largest developer in the People's Republic with various other business activities, is threatening to collapse under its enormous debt burden. Fear of contagion is spreading.

«There is a huge surplus of appartements on the market, and if they start to discount their value then everything would go down to like 20% of where it is now.»

«There is a huge surplus of appartements on the market, and if they start to discount their value then everything would go down to like 20% of where it is now.»

Anne Stevenson-Yang has been drawing attention to the risks posed by China's real estate market for some time; including in this interview with The Market/NZZ. The American lived in China for more than 25 years and, through her research firm J Capital, focuses primarily on Chinese companies that are cooking their books, making them candidates for short bets.

«If Evergrande and/or other developers were to default, and if demand for commodities in the construction sector goes down, you could see deflation spewing out of China throughout the world,» Stevenson-Yang says of current developments. «Then again, they have been extending and pretending for 15 years, so maybe they still will,» she adds.

In this in-depth interview with The Market/NZZ, the China expert explains what she thinks will happen next with respect to the Evergrande fiasco, how the People's Republic will change economically and politically in the coming years, and what that means for investors in Alibaba, Tencent, and other privately held Chinese companies.

Ms. Stevenson-Yang. Evergrande teeters on the brink of default. What’s your take on China’s giant property developer?

The property bubble in China has been going on for a very long time. And here’s the thing: If Evergrande were allowed to discount its inventory by 50%, then it probably would be solvent. But Evergrande can’t do this because everybody would be up in arms. This is the great secret in the Chinese economy: Property is actually a speculative asset, it’s not some place you live. Hence, there is a huge surplus of appartements on the market, and if they start to discount their value then everything would go down to like 20% of where it is now. They can’t do that. They’re stuck.

How did the Evergrande crisis come about in the first place?

This is the problem with all sorts of assets in China: You’re always running into, say, a taxi driver in Shanghai who owns three or five apartments. That’s quite common in the big cities because a lot of people in low-end jobs have families who used to be farming families. At some point, they’ve traded their farmland for maybe three units of new apartments. So if you’re driving around with these guys who are humping cars eighty or ninety hours a week, living on instant noodles and barely getting by, they will tell you that their appartements are worth $3 million.

But why don't these owners just sell their apartments? Wouldn’t that enable them and their families a substantially better life?

If you actually ask the question, they always say: «I would just have to buy another place.» But that’s just because the sale is a notional thing. It’s not a real possibility, since there isn’t any real market. They notionally have this highly valued property whose real worth is much lower. You’ll find this all over China.

What will happen next in the Evergrande saga?

The typical case in China is that the bondholders take a big haircut, 40% or something like that. But they all agree, there is no visible default. The equity owners lose around 75%. The people within China who have invested in the wealth management products, the loan securities, lose out entirely. But the real estate projects that are unfinished get handed over to other developers or cities. The affected people in those cities have probably made a down payment and still have around eight years left on their ten-year mortgage. That’s an income stream to the cities, so they can pick up the construction. But that’s the big problem with Evergrande. They have all these apartments that have already been sold like two years ago but not actually built.

There’s talk that China now potentially faces a «Lehman Moment». Does this comparison accurately describe the situation?

«It's not just Evergrande. Throughout the property sector, there were a whole lot of bankruptcies earlier this year, and there are a lot of listed property developers like Fantasia, Guangzhou R&F or Country Garden whose bonds are trading at pennies to the dollar. All of them are looking very shaky.»

«It's not just Evergrande. Throughout the property sector, there were a whole lot of bankruptcies earlier this year, and there are a lot of listed property developers like Fantasia, Guangzhou R&F or Country Garden whose bonds are trading at pennies to the dollar. All of them are looking very shaky.»

It's not just Evergrande. Throughout the property sector, there were a whole lot of bankruptcies earlier this year, and there are many listed property developers like Fantasia, Guangzhou R&F or Country Garden whose bonds are trading at pennies to the dollar. All of them are looking very shaky. There’s also a lot of strange political stuff going on in the banks. So it's a bit hard to figure how broad this thing is, whether it's containable or not.

What are the political consequences of these recent developments in China’s real estate sector?

The political risks are so enormous that China always finds some way to push these things under the rug. That doesn’t mean there aren’t very severe consequences, they’re just not going to be so visible to us. But it’s not going to be a financial crisis. Although – it might be, but not for China: If Evergrande and/or other developers were to default, and if demand for commodities in the construction sector goes down, you could see deflation sort of spewing out of China throughout the world, the Chinese Renminbi devaluing and so on and so forth. Then again, they have been extending and pretending for 15 years, so maybe they still will.

The stocks of major iron ore producers such as BHP, Rio Tinto and Vale have suffered a setback in recent weeks. In China, there also seem to be mounting protests by homebuyers and retail investors over the Evergrande fiasco. To what extent do the authorities see this as a political threat?

What tends to happen is that the investors in the loan securities, the wealth management products, don’t have a huge amount of political traction. They can’t develop a following from province to province because the securities they invest in are always a little bit «gray market», there is always something a little bit illegitimate about them. So the authorities always have at least one straw to lean on by saying: «You shouldn’t have done that.» But the people whose apartment values are dropping when they haven’t even moved in get really mad. So the question becomes: Can you control the information? By how much do these apartments’ values drop? Is there contagion? That’s why control of information becomes very important.

It’s well known that CCP General Secretary Xi Jinping intends to declare himself president for life next year. What does the Evergrande crisis mean for his political plans?

For a number of reasons, historical and current, the Chinese Communist Party always organizes through these big campaigns and they are very often hitched to these big anniversaries. Next year is the 20th Party Congress where they want everything to be perfectly in alignment and externally beautiful. I’m sure the impending collapse of Evergrande has a lot to do with how Xi Jinping has been tightening the screws on all the domestic private enterprises.

It’s not just Evergrande and other real estate behemoths. In the past months, Chinese regulators shocked western investors with the crackdown on tech giants like Alibaba, Tencent and Meituan. What’s behind these measures?

«One of the underestimated issues by the foreign press is the degree to which the Trump presidency has had an effect on China.»

«One of the underestimated issues by the foreign press is the degree to which the Trump presidency has had an effect on China.»

One of the underestimated issues by the foreign press is the degree to which the Trump presidency has had an effect on China. They look around the world and they see how this guy, this charlatan, just by virtue of having a lot of money managed to take tremendous power internationally and nearly tear down the United States which is a much more stable country than China. That had to strike fear into the hearts of the Politburo. They have to feel that they have to make sure there aren’t any Chinese billionaires who can do the same thing as Trump. They already had the example of Guo Wengui, also known as Miles Kwok, who fled to New York, got a penthouse and started a popular YouTube channel. They also have Jack Ma who had a very popular blog. So they have to be afraid of what could happen if they don’t take measures now.

And what’s the connection to Xi Jinping’s efforts to consolidate his power?

Another issue that people tend to not appreciate fully is that CCP leaders like Xi really do believe in Marxism. It’s kind of funny because no one else does internationally anymore. Marxism is probably the most disproven theory next to Freudianism. But these people were brought up on it and truly believe that the world is going through historical stages, driven by dialectic. They believe that capitalism is a precursor to socialism which is a precursor to communism. So they feel the capitalist stage is ending.

How does this fit into China’s strategy when it comes to economic policy?

They just feel capitalism had its purpose, and now we need to fold up and move toward actual communism. Capitalism generated a lot of money. There is a great anecdote in the book «Red Capitalism» about the time in 1978 when Deng Xiaoping decided that he was going to visit the United States. So he calls around to all the big banks in China and he says he needs some US dollars. But they didn’t have any. The total amount of US dollars in China at that time was like $30,000 which was not enough for the air tickets and hotel rooms for the whole delegation. So Deng Xiaoping came to realize that he had to do something to generate foreign capital. The first plan was export oriented enterprises because then they could be segregated in little zones and not really touch the rest of China. And when you export you get hard currency. So little by little, over the next forty years China developed this massive stash of hard currency. That was the purpose: to aggregate capital to develop a lot of infrastructure, to pay for a lot of stuff, and then to move on.

How will China thus interact with the world in the future?

China never has really liked to interact with the rest of the world. Chinese institutions go out to the rest of the world as if you were a diver in a diving bell: You have your diving suit on, you have your oxygen hooked up, and you try not to get too far from your diving bell because you’re too scared to be in the ocean. That’s the way China interacts. They would prefer not to. So the attitude toward international institutions is: We create a thin interface, just what we have to in order to take things from the international system, get what we need, and then return to the mainland. I think that’s what’s coming up: a closing of the mainland, letting fewer people out, having less interaction with the world.

Doesn't China want to rehabilitate itself as a global super power that plays a leading role in world affairs, as it did back in the days of the mighty imperial dynasties?

I don’t see China being very interested in international involvement and being a world leader. It does want to appear that way to its people because it’s part of the Party's promise that China will overcome the century of humiliation, the term to describe the period of intervention and subjugation by Western powers and Japan from 1839 to 1949. So this idea that China now can stand on its feet and it’s all thanks to the Communist Party is an important narrative to them. I think that’s quite different from reality. The interest in participating in international institutions is not really there. The interest in China is: We have to make as much money as we can internationally. That’s it.

So how will China’s future look? Like a hermetically sealed system comparable to the former Soviet Union and the era of the Iron Curtain?

«I would say that we know more about North Korean politics than we know about Chinese. That’s a pretty amazing thing.»

«I would say that we know more about North Korean politics than we know about Chinese. That’s a pretty amazing thing.»

I think that’s a good analogy. You can also look to China’s own fairly recent past. It was basically closed off to the international world through the 1970s. So from time to time, some farmer would manage to swim across the straits to Taiwan or Hong Kong and then everybody would zero in, and interview the guy, and ask what’s happening in politics in China because we had no information. I would say that we know more about North Korean politics than we know about Chinese. That’s a pretty amazing thing.

Accordingly, could the crackdown on the Chinese tech sector also be related to an attempt to control the flow of information?

I wouldn't say that it's the internet or tech per se. It’s more the way that private entrepreneurs have gotten all this money. Tencent and Alibaba are particularly targeted because in 2009, when all the stimulus began in the aftermath of the Global Financial Crisis, there were huge banks for the state actors but there were no banks specifically for the private sector. So Tencent and Alibaba kind of stepped into that gap and became banks for the private sector. In this process, they became enormous and uncontrollable, and they developed all of these foreign currency assets, especially Alibaba and Ant Group. That’s what’s being targeted. It’s not so much that they’re tech companies. It’s just that they’re very large, that they’ve created big fortunes and that they have hard currency.

Alibaba’s shares are down nearly 50% from their all-time high in October 2020. Other Chinese tech equities are down significantly as well. At what point do these stocks become a value play?

I can’t have an opinion on whether the stock is going to rise or not because that all has to do with the flow of funds. In my view, Alibaba and generally speaking Chinese equities are not stocks that you should hold for value. The idea of entering when the stock price is at a low point is a value idea, that you are going to hold it for a long time. That’s not something you can do with Alibaba because we just don’t know what’s inside it. The company's reports are very vague. You can’t know whether this company is ever going to generate any cash. The answer is probably not.

At the end of the day, what will be the fate of Alibaba, Tencent and China’s other tech behemoths?

What I’ve always thought about Alibaba is that the telecom companies had their eye on that business. They would love for the share price to get low enough. I imagine China Mobile will be waiting for Alibaba to sort of drop to a $70 range and then take it out. But that’s just a guess. I certainly know that before Alibaba listed, China Mobile and China Telecom all had study groups to see whether they could buy the company before it listed.

In some way, it all started last fall, when China suddenly halted the IPO of Ant Group, Alibaba’s digital payment platform. Was this the writing on the wall?

I was surprised that Ant ever said that it was going to IPO because it would be very inconvenient to actually disclose what’s inside of Ant. This would be devastating for Alibaba because the two are linked. If Ant disclosed its financial statements, it would show how Alibaba is manipulated. Of course, the government was not happy when Jack Ma made his speech about financial regulation. So that was a good excuse to take down Ant.

Last week, Casino stocks took a big hit as well. Could Macau's gambling industry be the next target in China's crackdown on the private sector?

There is a broad intention to curtail the private sector and to attach as many assets as possible. But I have no idea whether there is any direct relationship between Alibaba, Tencent and the casinos. The casino business has always been a direct function of stimulus money being poured out of the mainland. That’s why it’s not surprising that revenues have been declining and that the share prices are down. But I don’t really know what’s going on. They are trying to get hold of essentially mafia control of banks, and the casinos have a lot to do with that. That also has a lot to do with Zhuhai which is right across the bridge from Macau. But the precise dynamics, I don’t know.

After all we've learned in recent months, have Chinese companies become generally un-investable?

«I don’t want to be too harsh, but with Chinese companies it’s like a shadow play: You present what you want to present.»

«I don’t want to be too harsh, but with Chinese companies it’s like a shadow play: You present what you want to present.»

I don’t want to be too harsh, but with Chinese companies it’s like a shadow play: You present what you want to present. You don’t want people to be able to find out information randomly. You have to be able to show them what you want them to see. Chinese stocks have never provided accurate and clear information on what's actually going on. Nobody’s going to be going into Chinese stocks - 10 years ago or now - because they have long-term value, or such investors are deluding themselves. You go into Chinese stocks for momentum reasons because that's the direction that funds are going. That worked very well for quite a long time, but I think it's not going to work anymore. So if I were managing a portfolio, I would certainly get my money out of China. But, you know, people like Ray Dalio differ.

Is there no way for prudent investors to get exposure to Chinese companies?

I guess I would be looking at government associated companies. A lot of those are mainland listed A-Shares. Kweichow Moutai for example will never be attacked because it’s military. Or China Mobile or CNPC, companies like that. None of these are really fast-growing companies that provide huge returns, they’re just safer. But you invest in China for growth, not for safety and return.

There’s also the government's drive for economic equality. How do Xi Jinping’s announced plans to spread «common prosperity» fit into the big picture?

I don’t think that shows any particular interest in actual equality. I think all of this rhetoric suggests that the government needs tax revenue. You don’t do these things just theoretically. We have gotten hints here and there of provincial governments that have seen tax revenues plummet. So they need to do something. I’m sure they’re thinking and thinking of what to do, and one of the ideas that has come up was: «Let’s enforce income taxes on the wealthy because they don’t matter politically.»

Why then is China’s government on the hunt for taxpayer money?

Clearly, there has been a Covid problem for quite a while. We know that from value chain disruptions and from the quarantines. If it takes foreigners four weeks to get into Beijing, you can be sure that Beijing's economy is not doing great. Then that would be true of Shanghai and Shenzhen as well, and those would provide a good 25% or more of tax revenues to the nation. And then the northeastern provinces and the rust belt are going to be much worse. A lot of these provinces like Liaoning and Inner Mongolia covered up the decline in their industry by selling land. When the real estate market was rising, they looked ok because they were getting tax revenue from construction firms, and they were getting land revenue and appreciation. But as that starts to dwindle then, as Warren Buffett says, you see who’s swimming naked. And swimming naked would be the northeastern provinces like Heilongjiang, Jilin and Liaoning.

So what’s going to happen next? New stimulus measures to jolt the economy?

It certainly feels that way. When Xi Jinping took over in 2012, he had a tremendous amount of determination to end the refinancing of loans and stimulus to the financial system. The Chinese government held on for about six months, and then the economy started to go south. It looked terrifying, so they opened the taps again and poured money into the economy. One could imagine this kind of dynamic occurring again, where they try really hard to sort of turn the dials: They let a lot of private developers take losses, they restructure, redistribute the assets and raise taxes. It’s a familiar pattern. They try a lot of those relatively little things and all of a sudden, as the economy really tanks, they go: «Oh my God! We have to stimulate!» That’s the only real lever they have: collect money and then pour money on the economy to create a fire.

Anne Stevenson-Yang

Anne Stevenson-Yang is a co-founder of J Capital Research and is J Capital's Research Director. The firm publishes high-diligence research reports on publicly traded companies, relying on deep, on-the-ground primary research. Founded late 2010 in China, the company has particular expertise in the Chinese market but looks at overvalued companies throughout the world. Ms. Stevenson-Yang was formerly co-founder of a group of online media businesses in China and also founded and operated a CRM software company and a publishing company. Over 25 years in China, Anne has also worked as an industry analyst and trade advocate. She authored the 2013 published Book «China Alone: China's Emergence and Potential Return to Isolation», arguing that China historically repeats a cycle of expansion and retreat. She periodically shares her thoughts on current developments in the People's Republic in a column for «Forbes» and as an op-ed contributor for The Market/NZZ.
Anne Stevenson-Yang is a co-founder of J Capital Research and is J Capital's Research Director. The firm publishes high-diligence research reports on publicly traded companies, relying on deep, on-the-ground primary research. Founded late 2010 in China, the company has particular expertise in the Chinese market but looks at overvalued companies throughout the world. Ms. Stevenson-Yang was formerly co-founder of a group of online media businesses in China and also founded and operated a CRM software company and a publishing company. Over 25 years in China, Anne has also worked as an industry analyst and trade advocate. She authored the 2013 published Book «China Alone: China's Emergence and Potential Return to Isolation», arguing that China historically repeats a cycle of expansion and retreat. She periodically shares her thoughts on current developments in the People's Republic in a column for «Forbes» and as an op-ed contributor for The Market/NZZ.