The collapse of Lehman Brothers helped trigger the global financial crisis. Evergrande is not a Lehman moment, given that China is not the epicenter of the global financial system. But both Lehman Brothers and Evergrande have been riding a wave of liquidity created, in part, by excess Chinese savings. This does not allow the managers and regulators of these companies to get out of the woods. Rather, it reveals how they were both able to rise so far and get away with it for so long.

Excessive savings facilitate loans that otherwise would not exist. China’s excess savings have led to successive deficits across the world. Before 2011, the undervaluation of the renminbi allowed China to export its savings. The first foreign balance sheet to soar and then cut back on Chinese surpluses was the US household sector, peaking with the subprime mortgage crisis. After that, the US government intervened briefly, but then it became politically unacceptable.

Emerging markets followed, but it was clear that they were nowhere near big enough. The result was the taper tantrum of 2013.

Even the Chinese corporate sector ended up hitting the wall. From 2016, Chinese households took up the challenge. Attempts by Chinese companies to improve financial balances meant there had to be a deterioration somewhere. Chinese household balance sheets were the latest to liquefy excess savings, allowing Evergrande to continue to misbehave. This liquidity has helped ensure that real estate prices continue to rise, allowing developers to continue borrowing and driving up land prices.

In November of last year, the authorities introduced three red lines: limits on corporate debt ratios, debt-to-equity, and cash-to-short-term debt. Indeed, they have forced cash-dependent businesses to go cold turkey. M1 growth slowed sharply. Growth in gross domestic product in the third quarter of 2021 is expected to be weak, with new restrictions on Covid-19 exacerbating the pain. This combination was enough to derail Evergrande and others.

The web around Evergrande and other developers is complex, with owners of real estate assets dotted throughout the economy. Preventing distress from spreading will be difficult and decisive early action is essential. The only reason the contagion has not yet spread is that the People’s Bank of China is providing large injections to the interbank market. But the system will need a more permanent injection of liquidity.

Banks should also be forced to lend to property developers again. Suppliers and employees paid in receivables will have to be bailed out, to prevent them from offloading assets and creating a downward spiral in prices. The more the situation worsens, the more likely it is that the authorities will have to take on the responsibility of recapitalizing the banking system.

There is a distinction between the current situation and the subprime crisis. International financial exposures are less severe. But the relatively modest direct exposure of major asset managers to Evergrande offshore bonds underestimates the problem. As this question of exposure develops, so will the uncertainty. Authorities could funnel dollars into the problem. But China’s foreign exchange reserves are not what they used to be, having fallen to 19% of GDP in the second quarter of 2021 from 37% in 2015. Fortunately, dollars remain plentiful around the world, due to the response. policy to the pandemic.

The implication for international investors in both cases is that the renminbi must depreciate. The question is about the timing. There are no more balance sheets in China, which means that surpluses will again seek foreign surpluses, requiring a cheaper currency. Or to put it another way, GDP growth has hit a wall, and differentials were already pointing to depreciation towards the end of this year.

The PBoC is already pumping cash and it will have to put in more before the end of this Evergrande saga. If the foreign exposures and the associated uncertainty are greater than expected, the pressure on the currency could become severe. At this point, the data to confirm the exposures probably does not exist. It could become part of the problem.

The Chinese real estate market is down, eliminating a key driver of demand. In the medium term, the road to net zero will still dominate commodity prices, providing an internal source of demand for China and limiting the need for renminbi depreciation. For global equities, the better The scenario is that China-linked earnings weigh heavily on global equities at a time when valuations already appear stretched.

So far, the time horizons here are for the next year or two. But reaching the latest balance sheet is more important than that and raises serious questions about the future of the global economy. Chinese households may not be the last balance sheet to take on debt in the sense that equity is becoming a more important form of financing. They may even have room to take advantage of during the next cycle. At the same time, China’s monumental need to green the economy could use up more of these excess savings domestically.

However, the slowdown in global growth in each cycle, along with increasing inequality and declining average incomes, has reached a political dead end. The conception of market policy developed for the 1970s gave way to the recognition of a need for investment in infrastructure, financed by public debt if necessary, which in turn could help free up spending on infrastructure. private investment and productivity rebound. Hopefully China’s woes are not too great, as the appreciation of the dollar would be a major drag on this revival in GDP growth.

Freya Beamish is a Senior Economist at the Macroeconomics Hall of Fame