TheChek News Flow

This is a seemingly absurd question, yet some are asking this in Washington. The Middle East is the source of massive reserves in oil and gas. Much of the fuel to produce goods and trade from Asia and the EU comes from the Middle East. Much of the world economy relies on Middle East energy. The region has strategic chokepoints like the Strait of Hormuz, The Suez Canal, and The Bab al Mandab. It is a source of some of the more significant threats in the world, such as from ISIS, Al Qaeda, and other groups. It contains some of the most important security connections in the world. Consider the neighbors of the Middle East and not just the Middle East. The Middle East is a crossroads for energy and security. It also could be one of the generators of change and improvement, if it is allowed and supported to do so.

Consider the slow to no reaction to the shipping of Iranian fuel with the help of Hezbollah and Syria to Lebanon.

The U.S. could have done many different things to help the Lebanese with this without handing a massive public relations and political victory to its adversaries. But, in some ways, Washington’s sanctions have painted it into a corner on such issues. Consider how the U.S. took the anti-missile batteries from Saudi Arabia as the Houthis are still attacking Saudi Arabia with missiles. The Saudis made a deal with the Russians in response to this and other moves by the U.S. The U.S. handed leverage to the Russians. These are just two of many examples of how the plot is being lost.

Indeed, China is a threat in the Pacific to Taiwan and others. It is a threat to the freedom of navigation in the Western Pacific. It is an economic and technological threat to the US and has been for a very long time. It is a cyber threat to the US. It is developing leverage in many countries with its Belt and Road Initiative. It is now the largest trading partner with almost all Middle East countries. It is building significant diplomatic, economic, and even military leverage in the Middle East. China is moving into the region as the U.S. moves in other directions. By the way, it is getting more likely that China could have a piece of the nuclear power pie in Saudi Arabia.

Russia has also been creating greater leverage in the region. Its recent big defense deals with Saudi Arabia are just one example. The U.S. basically opened the door to them. Similar things happened when the U.S. cut back on defense aid to Egypt a few years back. The Egyptians were in Moscow in quick order to make defense and other deals. Russian advisors are back in Egypt. The Russians are building a huge nuclear power complex on the north coast of Egypt. There is no doubt that the Russians have far more clout and leverage in the region than before. Much of this is due to missteps by the U.S. or simply U.S. neglect of this vital region.

The U.S. should be in the running on nuclear power plant exports and other crucial leverage-giving exports in the region. We could export small modular rectors to the region. These have much lower proliferation and safety risks than older, larger plants. We could further develop the safety of this trade by applying 123 agreements as we did in the UAE. The UAE has the gold standard nuclear power agreement with the US even though the plants were built by a Korean company.

Why am I mentioning nuclear power plants? Because whoever exports a nuclear power plant to another country can develop 80 to 100 years of leverage and clout in that country. Nuclear power plant exports are dominated by Russia with China second. The U.S. is not even in the running.

We have seen above some examples of how the Russians and Chinese are building leverage and clout in the region. If the U.S. wants to turn more to the “Great Powers Conflict”? Then it should realize that the “Great Powers Conflict” is not just in Asia, but also in the Middle East (and Asia begins in the Sinai). The Middle East is a contested space.

One cannot win a backgammon and chess game by letting the other sides, one’s adversaries, make clever moves while we do not have good counter moves and we do not think many moves ahead.

The U.S. seems to be losing the plot of the 4D chess game in the Middle East. It is not too late to rethink strategies. The U.S. needs to be in the game for the long run and think in the long run. The U.S. needs to regain the plot in the region and how it connects with the big pictures in geopolitics, geo-economics, energy, security, and much more. It is not too late.

Well, as we warned, the Evergrande contagion has finally arrived and with China closed for holiday traders are getting out while they can and where they can, and on Monday morning in Asia that means Hong Kong, where Evergrande - which is about to default - has crashed by another 13% this morning and is on track to close at its lowest market cap ever (to be expected ahead of a bankruptcy that will wipe out the equity)...

... and with Evergrande property development peers such as New World Development & Sun Kung Kai Properties both down over 8%, and Sunac China and CK Asset plunging over 7%, the Hang Seng property index has crashed more than 6%, its biggest drop since 2020 to the lowest level since 2016...

... and the broader Hang Seng index is down 3.5% in early trading, to the lowest level since November 2020.

And with traders on edge about the rapidly spreading contagion (as we described earlier) even sectors supposedly immune to China's property woes, such as the Hang Seng Tech Index are plunging, sliding as much as 2.7%.

And speaking of Evergrande's imminent default, we noted earlier that while the company is scheduled to pay $83.5 million of interest on Sept. 23 for its offshore March 2022 bond, and then has another $47.5 million interest payment due on Sept. 29 for March 2024, the day of reckoning may come as soon as Tuesday: that's because Evergrande is scheduled to pay interest on bank loans Monday, with a one-day grace period. In other words, should it fail to arrange an extension, it could be in technical default as soon as Tuesday (for a much more detailed analysis of next steps please see "This Is How Contagion From Evergrande's Default Will Spread To The Rest Of The World".) Spoiler alert: a default is coming because Chinese authorities have already told major lenders not to expect repayment.

Incidentally, as Bloomberg's Mark Cranfield notes, Hong Kong stocks can't blame low liquidity for the meltdown as "trading volumes on the Hang Seng and H shares indexes are running well above the 10-day average on Monday as both drop by ~4%."

There's more: junk-rated Chinese dollar bonds slid by as much as 2 cents, according to credit traders, pushing their yield to just shy of 15%, the highest since 2011.

Other sectors are also getting hammered, such as Ping An Insurance, China’s largest insurer by market value, which plunged 7.3% in Hong Kong.

“Investors may be concerned about highly-geared names and don’t care about valuation nowadays,” said Philip Tse, head of Hong Kong & China Property Research at Bocom International Holdings Co Ltd. “There will be further downside” unless the government gives a clear signal on Evergrande or eases up on its clampdown on the real estate sector, Tse said.

Meanwhile, pouring gasoline on the fire, Goldman's China anlyst Hui Shan published a note (available for professional subs in the usual place) on Sunday in which it discussed the rising risks from the property market, writing that even without the Evergrande debacle "housing activity fell sharply in July and weakened further in August" largely in response to China's structural reforms in the property sector (such as the "3 Red Lines"). At the same time, "concerns over Evergrande are rising and signs of financing difficulties spreading to other developers are emerging."

In the note, Goldman also estimates the potential impact of the coming property market crash on Chinese growth under different scenarios, which can be described as bad, worse, and terrible, with the bank expecting a GDP hit anywhere from just over 1% to as much as 4.0%. Needless to say, such an outcome would be devastating not only for China but for the world.

Looking ahead, Goldman notes that while for now, its baseline remains that any potential default or restructuring of Evergrande would be carefully managed by the government with limited contagion effect in both financial and property markets "this would require a clear message from the government soon to shore up confidence and to stop the spillover effect, the absence of which we think poses notable downside risk to growth in Q4 and next year."

In short, as we explained previously, it all depends on Beijing whether the current selloff accelerates, or if we see a furious surge as Beijing directly or indirectly injects another cool trillion or 10.

Meanwhile, as Bloomberg's bloggers write echoing what we said yesterday while traders may have been hoping there would be some clarity on the road ahead for the company, given it has bond payments due this week, "the complexity of the case may be the reason for a lack of communication from the authorities. That compounds the uncertainty for investors, and with China on holiday, the momentum for lower Hong Kong stocks are picking up pace."

So while contagion is clearly hammering Hong Kong in lieu of the shuttered China, it is also spreading to Australia where the Aussie dollar is mining stocks have slumped as iron ore prices continue to collapse, with the industry group falling 4%. Among the biggest movers, Champion Iron fell as much as 12.5% in early trade Monday, continuing a four-day losing streak while Fortescue Metals dipped as much as 7%, falling to the lowest price since July last year.

Contagion has also moved beyond merely stocks, with US equity futures trading as low as 4380..

... and is starting to impact both commodities, with Iron Ore tumbling more than 10% on fears a Chinese property crisis will lead to collapsed demand for steel, as well as FX, with the dismal mood lifting USD/HKD to the highest for September, and while USD/CNH is firmer, but for now, that is in line with broad dollar strength. Should EUR/CNH start trending higher, Bloomberg notes, "that would be a signal traders have become anxious about the health of the yuan amid the equities slump."

Incidentally, it is hardly a secret that the bigger the market crash, the more likely Beijing is to do something to bail out the market and tens of millions of very angry Chinese investors who may soon show Nancy Pelosi what an insurrection really looks like. But should the silence out of Beijing persist, it's only a matter of time before the "anxiety" hits levels not seen since Sept 2008 as an outcome most traders thought impossible becomes inevitable.