China’s Growing Debt Crisis

A pile of RMB banknotes Chinese yuan money
A pile of RMB banknotes Chinese yuan money

The threat of another global financial crisis sank equity markets on September 20, 2021, after news broke of a Chinese development company that was on the verge of defaulting on more than $300 billion dollars’ worth of debt. This event contributed to a growing tension in the United States surrounding the potential of defaulting on the country’s national debt that is fast approaching $29 trillion dollars. The combination of domestic and global debt issues creates a lethal mixture for Wall Street investors that could potentially cause one of the most disastrous market events in history—especially if the United States government defaults on their national debt. 

Evergrande Group, one of the largest development companies in China, was under increasing pressure to make interest payments to bondholders as they stated in a financial filing earlier in September that they could not guarantee that those payments would be made. This uncertainty spread fear among investors in China and Hong Kong as Asian market indices lost 3% or more. The fear of default quickly spread all the way to Wall Street, which shed 2% on September 20, 2021, and caused American investors to lose tens of thousands of dollars in one day before rebounding in the days that followed. 

A contagion of fear was the culprit for the decline on Wall Street and despite the rebound in the days that followed the 2% crash, an unsettling sentiment remained that this may just be the calm before the storm. Evergrande had multiple bond interest payments to make on September 22 and September 23 and missing either of those payments would bring the company to the brink of collapse and threaten to destabilize China’s economy. Investors are split on their speculation of a potential default from Evergrande as some believe that a default on more than $300 billion dollars will not have a global effect, encouraging Wall Street investors to remain steadfast in their holdings. Other experts, however, have drawn sharp comparisons between the Evergrande situation in China and the Lehman Brothers group, whose collapse in the late 2000s served as a catalyst for the 2008 global financial crisis. It should be noted however, that Evergrande is not the only Chinese company that is facing debt concerns. Another Chinese development company, Fantasia Holdings, is also having debt concerns.  

If Evergrande were to collapse on their $300 billion dollars of debt, it would be the second largest debt default in history, even outpacing Greece who restructured $200 billion dollars of debt during their 2012 collapse. The largest to date occurred in 2008 when the Lehman Brothers group defaulted on more than $600 billion dollars of debt and ignited a spark that led to the global financial crisis. Currently, there are some economists that dismiss the Evergrande situation as having the ability to cause a global financial crisis, but others are not so sure. Wall Street investors quickly panicked and even if the selloff was based on a contagion of fear, the fact of the matter is that the stock market still suffered critical losses as a result. If Evergrande and other companies in China start to default on their debt payments, it absolutely would have a broad impact on global equities, especially if the situation grows. This is a developing situation that could last for several months as bond interest payments will be due for the debt-laden development company every month for the remainder of the year. 

On top of the Evergrande Group situation, federal officials in the United States are racing against the clock to come up with a plan to avoid what would be the largest default in history. In 2019, former President Trump suspended the debt ceiling for two years. At the time, the national debt was roughly $22 trillion dollars and was signed several months prior to the start of the coronavirus pandemic. When the debt ceiling suspension officially came to an end during the summer of 2021, the national debt had increased $6 trillion dollars and was fast approaching a total of $29 trillion dollars. Congress failed to pass a budget proposition with a debt ceiling provision prior to their summer recess and this forced Treasury Secretary Janet Yellen to implement extraordinary measures to maintain the government’s financial obligations while congress attempted to find a solution. The problem that lawmakers are waking up to today is the exhaustion of those extraordinary measures and a fast-approaching October 18 deadline to avoid a national default. 

Secretary Yellen has pleaded with members in both parties in the House and Senate to pass an official resolution to avoid what she believes will be the most catastrophic financial crisis in history, potentially sending the United States into another recession. Federal Reserve Chairman, Jerome Powell, also expressed concern about the national debt during a press conference where he made the point that it’s difficult to contemplate the consequences of failing to raise the debt ceiling, but the United States should not wait to find out. To make progress in the debt debate, President Biden met with Congressional Democrats and progressives to discuss his $3.5 trillion dollar spending package, including the debt ceiling, but no progress has been made and Republicans in Congress have stated that they have no intention of voting to raise the debt ceiling any further.

The United States faces a very real possibility that the government will default on its national debt despite having raised or suspended the debt ceiling countless times over the last several decades. The outcome of this worst-case scenario is inconceivable for investors with at-risk assets. In conjunction with these domestic issues, investors must now keep a watchful eye on the debt crises occurring in other parts of the world, especially in China where multiple companies are now struggling with debt obligations. What was anticipated to be a year of progress and recovery quickly unraveled into an uncertain mess that clouds future expectations for the economy, investing, and even the state of politics, as lawmakers will soon shift from a legislative mindset to a campaigning mindset for the 2022 midterm elections—if they haven’t done so already.