22 November 2021
"Economics is the study of mankind in the ordinary business of life" ― Alfred Marshall
Welcome to the Economic Surplus, the newsletter brought to you by the Marshall Society! We are the University of Cambridge’s flagship economics society. Every week, we bring you our bespoke commentary on economic trends, updates on our exclusive members’ events as well as a summary of the headlines you can’t ignore! You’ve probably received this email because you were previously subscribed to the Marshall Society’s old email list, but if you have been forwarded this by a friend, feel free to subscribe here!
The Marshall Society is proud to host Grant Fitzner. Grant Fitzner is the Chief Economist at the Office for National Statistics. Previously, he held a range of public and private sector roles, including economic adviser to the Australian Government.
Event’s topic: ‘A tale of two recessions: The global financial crisis and pandemic recession compared’. The event will include a Q&A session from the audience.
The interview with Mr Fitzner will take place in person on November 24 at 7 pm, with the location of this great event being in the Riverside Suite at the Unoversity Centre. The event is open to Marshall members only.
If you are interested in becoming a member, please go to: https://marshallsociety.com/join-us/
Marshall Mentorship Programme
Would you like to receive mentorship advice from recent graduates working in Management Consulting, Investment Banking, Sales and Trading, Asset Management, Equity Research, Private Equity and more? We would like to present you with an exciting opportunity to join Round 1 of the Marshall Mentorship Programme! Dedicated to Society’s members, the Programme gives you a chance to connect with our Alumni and receive invaluable guidance on professional and educational choices. The Mentors in the list all work in top firms in their respective fields, including Goldman Sachs, BCG, Credit Suisse, T. Rowe Price and Bain Capital.
Apply by 01/12/2021 (23:59), filling in the form below, where you will also find further details regarding the programme (please log in with your Raven or gmail). The number of spaces is limited, as each Mentor is assigned only one Mentee to ensure that more time and attention can be dedicated to every participant.https://forms.gle/G1o2hn87DZND2sVU6
In Conversation with Andrew Bailey & Mohammed El-Erian | The Cambridge Union - 5 PM, 25th November 2021
Andrew Bailey has been Governor of the Bank of England since March 2020. Prior to his appointment, he was the Chief Executive of the Financial Conduct Authority.
In this event, Andrew will be speaking to Mohamed El-Erian, President of Queens' College. Mohamed was previously Chair of President Obama's global development council, Chief Economic Adviser at Allianz, and twice a New York Times-bestselling author.
This event is for Cambridge Union members only.
This week’s Marshall’s Thoughts are written by Jeff Yang.
On October the 5th, terror penetrated the financial market as Fantasia, a prominent Chinese real estate developer, announced that it had missed the payment of a total of 206-million-dollar bond due on the same day, triggering formal default. Perhaps reminiscent of a similar Evergrande default a handful of weeks ago, headlines and commentators emerged with great vigor, calling this the end of the Chinese economic miracle, or China’s “Lehman Moment”. This could perhaps be backed by Rogoff and Yang’s estimation, where a 20% fall in Chinese real estate activity could lead to a 5-10% reduction in her GDP. Considering the immensity of such challenges, the question to ask is then: How did China get here? And how should China move forward?
Real estate is an inherent part of the Chinese economy, perhaps more so than any other nation. For an average Chinese household, housing assets consist of 66% of its balance sheet, due to said assets enjoying vast higher returns than the few capital alternatives. For the local governments, the fact that land supply is tightly controlled, and that land sale or debt financing using LGFP, structures that allow land-collateralized bank loans to be channeled to public welfare projects, is a much relied on source of fiscal revenue, closely ties the government to the real estate market. For many firms, real estate assets also remain the dominant collateral, with most gradually increasing land investment over time, partly for speculative purposes. Combined with massive national savings, China had thus become relied on property investment as a source of economic growth.
One of the consequences of such a booming demand in real estate was, mainly, rising prices. Many analysts have often pointed to the significant expansion in price indices compared to the local average income in Tier-1 cities, accompanied by the high real estate investment. Such combination has led to deep structural issues, such as, inter alia, the accumulation of debt. Due to cultural traditions and optimistic expectations regarding the housing market, Chinese households are becoming increasingly leveraged, with households’ debt to GDP ratio reaching 60% in 2018. The common use of LGFP by local administration additionally worsened this buildup in debt and pushed the growth of shadow banking activities. Indicators such as vacancy rates or the infamous ‘ghost cities’ long suggest the possible existence of a housing bubble, or at the very least excessive leverage of developers and excess capacity in the housing market of smaller cities.
This is where Evergrande comes in. Developers, in response to the high housing demand, had become relied on pre-sale as a business model, where housing units are sold before being constructed, thus enabling the firm to generate cash, satisfy liquidity needs, and then borrow to develop more properties. To this end, Evergrande and others created wealth management products to raise cash from retail investors and supplier commercial bills, tradable contracts to pay suppliers, both used to plug holes in the system. This model allowed Chinese developers to see an explosion in the total value of assets, with value of assets in construction even surpassing that of completed projects, and along with it, the rapid growth of the firm’s borrowing.
Yet, the model would finally break under a multitude of troubles. The 2020 pandemic saw a massive reduction in home sales, mainly due to the downward pressure outbreaks have caused on consumption, income, and indeed the balance sheet of stakeholders. This strained the developer’s cash flow, which led to even more growth in credit. Come August the same year, in a response to the larger debt caused by the pandemic, Chinese authorities announced a “Three Red Line” policy, causing a tighter credit environment and reduction in the ease of borrowing for indebted developers, thus making the model no longer sustainable, where insufficient financing blocked the developers from raising more cash. On top of declining contracted sales, Evergrande and Fantasia finally began to crack.
Whether the doom of these Chinese developers counts as a “Lehman Moment” still needs observation. Indeed, a major portion of the debt developers incurred are financial liabilities with dispersed creditors, whilst the banking sector exposures to them have been generally reducing through PBOC effort. Thus, it is possible to ringfence the contagion resulting from the developers’ collapse from the rest of the financial market. Beijing has also vowed to prioritize consumers and creditors to contain the further fallout that may occur, boosting market confidence. Yet, if China does march through such a crisis, she should again be increasingly wary of the medium-term issues in the economy that have foreshadowed such a crisis. Indeed, in response to the unsustainable financing mechanism the local governments have often undertaken and the speculation within the market, the NPC recently passed a resolution expanding trials of universal property taxes, as opposed to targeting only second homeownership, to more cities.
However, more measures must also follow to solve the fundamental issues plaguing the economy, including the aging population that may eventually destabilize housing demand. Some have noted that a shift in the Chinese economy from one relying on highly unproductive property investment to one relying on consumption may be necessary to avoid future buildup of debt and to improve public welfare. To this end, the idea of “Dual Circulation” and the slogan of “Achieving high-quality growth with Common Prosperity” may then suggest the right future path of China. Whether stability again trumps all, or whether more comprehensive reforms are undertaken, must require further observation. Yet, if there was anything China learnt from the reformist Liang Qichao, it was that “Large reforms create large gains, whereas small reforms create small gains”.
This article dives into the likely next nominee to Fed Chair, Lael Brainard, her views on central bank responsibilities, and her record as a member of the Federal Reserve Board. It also looks specifically at her belief that more proactive actions need to be taken by the Fed to tackle the unequal distribution of wealth very much rampant in the US. Following our interview of Ben Bernanke during the week, who discussed similar topics, this may be an interesting read.
This article discusses the US Treasury’s current lack of cash, and measures implemented in previous months to ensure government functioning and the prevention of default, such as increases in the debt limit. It also looks at the political process that may be involved in raising the debt limit, and what a default would mean for the US and global credit markets.
This brilliant piece of analysis dives into one of the hot topics in economics, the rising global inflation. It discusses the causes of this rising inflation and summarizes an ongoing debate between various economists on whether the rise in prices is temporary or permanent.
This article discusses the LGFP financing used extensively by local Chinese governments, and how the recent deliberate credit tightening, and the collapse of prominent private developers has led to a fiscal financing crisis.That's it from us for now!
The Marshall Society