Crypto and stocks tumbled this morning as a number of bearish forces converged on market sentiment. The first of which being yet another economic downgrade from Goldman Sachs following a previous GDP forecast reduction, issued two weeks ago.
The Wall Street bank trimmed its US GDP outlook, citing “fading fiscal stimulus” and the Delta variant as contributors to a slowed post-Covid recovery.
Goldman economist Ronnie Walker said that there would be a “harder path” forward in a Monday note to clients before revealing a 5.7% GDP growth forecast for 2021, down from Goldman’s already-reduced 6% estimate.
Last week’s disappointing August jobs report caused the bank to shift its labor projection, too. Goldman now expects an unemployment rate of 4.2% (vs. its prior 4.1% prediction) by year’s end.
“The hurdle for strong consumption growth going forward appears much higher: the Delta variant is already weighing on Q3 growth, and fading fiscal stimulus and a slower service sector recovery will both be headwinds in the medium term,” wrote Goldman analysts.
Morgan Stanley also issued a downgrade of its own this morning, classifying U.S. equities as “underweight.”
“We see a bumpy September-October as the final stages of a mid-cycle transition play out,” explained Morgan Stanley strategists.
“We continue to think this is a ‘normal’ cycle, just hotter and faster, and our cycle model remains in ‘expansion’. But the next two months carry an outsized risk to growth, policy and the legislative agenda.”
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To add insult to injury, cryptocurrencies crashed shortly after stocks opened for trading. Bitcoin, Ethereum, and virtually all other digital currencies fell double digits shortly before noon. Crypto has more or less tracked the S&P 500 ever since the Covid pandemic began. Today’s selling may have been sparked by a poor morning trading session for stocks.
But the majority of the crypto losses that followed were likely caused by something else, as equities didn’t drop nearly as much as crypto.
The market’s “smart money” – investors armed with inside information – could be dumping their crypto portfolios in anticipation of another financial crisis. This time around, though, it’s not an American company (like Lehman Brothers) causing problems.
Evergrande, China’s second-largest property developer, is to blame.
In addition to being a major real estate developer, Evergrande is also China’s largest issuer of commercial paper (very short-term corporate bonds). It earned this title after the Chinese government banned the company from issuing longer-term debt.
Normally, this wouldn’t be an issue. But Evergrande is now well on the path to bankruptcy. Creditors have pooled their resources, taking the company to court in an attempt to settle their debts – something that often precedes a bankruptcy declaration. Evergrande has liquidated assets, even selling its corporate headquarters, to pay said creditors.
Sadly, Evergrande’s efforts will be in vain. The company is essentially doomed to default with billions in debt coming due within the next year. Evergrande’s CEO recently held a press conference in which he projected supreme confidence and insisted that the company was doing just fine.
Lehman’s CEO, Richard S. Fuld Jr., made similar statements prior to Lehman’s epic $600 billion collapse.
The difference now is that everyone can see the Evergrande bankruptcy developing. A bailout from the Chinese government will be required to save the company, which owes roughly $305 billion in debt. As of August 31st, Evergrande only had roughly $355 billion in total assets. That’s enough to pay creditors if it’s able to liquidate everything.
Keep in mind, however, that Evergrande just sold its headquarters for a 66% loss. The reality is that the company won’t be able to liquidate enough assets in time nor for what they’re currently valued at.
Bankruptcy looms as a result.
I know what you’re asking:
“What does this have to do with crypto?”
Tether, a Hong-Kong based cryptocurrency that tracks the value of the US dollar (called a “stablecoin”), is backed by a significant amount of Chinese commercial paper. In fact, Tether claimed earlier in the year that 50% of its reserves come from commercial paper. How much of it is Chinese or specifically from Evergrande is unclear.
But the team at Tether has been very tight-lipped about the origin of the commercial paper. If it’s not from Evergrande, it’s safe to assume that the Tether execs would’ve said so.
Instead, Tether has kept quiet during Evergrande’s descent into insolvency. CNBC’s Jim Cramer went so far as to call Tether a “ticking timebomb” after anonymous “Chinese sources” told him most of the commercial paper was in fact Chinese.
This matters because Tether accounts for almost 80% of the volume of all crypto transactions. If the commercial paper that backs Tether fails, the actual value of Tether (USDT) could plunge below its 1-to-1, 1 Tether-to-1 US dollar ratio. In addition, the Tether team could also dump its sizable crypto holdings (including Bitcoin) to cover its commercial paper losses, hastening a massive crash as liquidity simultaneously shrinks.
This outcome assumes that China allows Evergrande to go bankrupt.
If the Chinese government bails out Evergrande instead, Beijing would become the company’s newest business partner. Recent private sector crackdowns by the CCP suggest that the government would more than happy with this outcome.
Should this happen, China would need to settle those debts with US dollars, not Chinese yuan. This is important as Beijing would then be forced to buy over $300 billion dollars, spiking the value of the dollar in the process.
That could then lead to an overnight “haircut” for all asset classes as the dollar surges, including both crypto and equities. In addition, a bailout may reveal a deeper “shadow banking” industry that involves other major Chinese corporations. There very well could be more companies like Evergrande out there (albeit smaller ones) that have yet to hit critical mass with their toxic debt issuances.
So, either by way of bankruptcy or bailout, 2021’s speculative mania has officially entered hazardous territory. Let’s not forget that a Fed taper is coming down the pipe in the near future as well.
“Smart money” investors could be trying to exit early, prompting this morning’s correction. Or, it could simply be a case of waning bullish enthusiasm.
Regardless, Evergrande still poses a significant threat to nearly all investors if it’s the latter. And not just those involved with crypto.
A major reckoning is developing in the Far East and the mainstream financial media hasn’t given Evergrande the emphasis that it deserves. This will all change, of course, when China steps in to save the company and asset values hit a sudden “air pocket.”
But until then, the market will remain focused on the numerous Covid variants threatening to reactivate lockdowns.
Even though a lack of government stimulus has had a far more profound effect on bogging down the US economy, which Goldman (and others) finally admitted this morning despite a far bigger story – the Evergrande bankruptcy – simmering beneath the market’s surface.