The Evergrande saga 'is the beginning of the end of China's growth model as we know it,' one consultant says. It means the whole world economy will change.

• Evergrande's looming collapse would be a shift in the story of "capitalism with Chinese characteristics."
• Xi Jinping has been centralizing power for years, and is now cracking down on firms that have racked up too much debt.
• The problem for Xi and China is the debt-fueled real-estate sector has also led much of China's growth, and the world has come to depend on a fast-growing China.

China Evergrande is ground zero for a colossal economic shift. Whether the real estate titan - formerly one of the country's biggest success stories - sinks or swims from here could reshape the whole world's economy.

Since the 1990s, China has served as the "factory of the world" on the back of a historic economic expansion. The country's share of world GDP has skyrocketed from around 1.6% in 1990 to 17.4% in 2020.

Certain companies grew at a blinding pace as the Chinese Communist party loosened debt conditions and offered cheap financing in a bid to drive expansion. They called this development "capitalism with Chinese characteristics."

Few companies tapped debt markets as aggressively as Evergrande. The firm is the country's second-largest property developer, with more than 1,300 buildings in 280 cities, according to a company website, while its expansion into other sectors has led to its ownership of two theme parks, an electric vehicle brand, and a football club. But the bill for this extraordinary borrowing is finally coming due.

Evergrande now owes more than $300 billion to investors, and a default could leave them without their cash or a home for some time. August regulatory filings signal the debt pile has overwhelmed the company. It warned investors in late September of "risks of default," and several credit downgrades followed. While this isn't the first big default China has faced, President Xi Jinping is now determined to reform the property market.

China is switching up its playbook for economic expansion, declaring an end to "expansion of capital without order." It has been cutting real-estate sector debt since 2017, arguing the trillions of borrowed dollars risk a financial crash. Separately, Xi's regulatory agencies have been cracking down and centralizing power everywhere from the recent ban on cryptocurrency payments to their suspension of a record-breaking IPO.

"This is the beginning of the end of China's growth model as we know it," Leland Miller, CEO of consulting firm China Beige Book, told The New York Times. "The term 'paradigm shift' is always overused, so people tend to ignore it. But that's a good way of describing what's happening right now."

Some on Wall Street agree. A Morgan Stanley team led by chief global economist, Seth Carpenter, wrote on Thursday that a "profound policy shift is under way in China, and policy-makers have initiated a far-reaching and wide-ranging regulatory tightening cycle."

Miller told Insider this shift has been a long time coming. "China is not and has never been a free market economy, even if it has enjoyed its own form of capitalism for several decades."

With Evergrande having weeks to pay up before it reaches default, the next form of capitalism in China could soon come into view. Nations around the world may find the end result to be a form of capitalism they've never seen before - and one that will have widespread ripple effects for their own economies.

China at a crossroads: free-market capitalism or government control?

Since letting Evergrande default would rock the Chinese economy, Xi is at a crossroads between capitalism with Chinese characteristics and ... something else.

"How do you prick a bubble that every single person, from homeowners to local governments, doesn't want pricked?" Travis Lundy, an independent analyst in Hong Kong, told The Washington Post. "Nobody really wants to see this unwind. If this does, there is going to be a lot of pain."

The transition from China's old way of doing business to a new one is creating crises elsewhere. Stringent regulations meant to curb air pollution have contributed to a dire energy crunch, as have bottlenecks slowing deliveries of coal. Power shortages led factories to shut down in 20 of China's 31 provinces, and millions of households have lost electricity over the past week. Yet the government's restrictions have stayed in place, forcing energy companies to ration electricity instead of passing on higher costs to consumers.

Fears of Evergrande's potential collapse are already spreading to other Chinese markets. Prices for risky high-yield dollar-denominated corporate debt have been plummeting in recent weeks as the crisis has dominated headlines. It's making borrowing more expensive for Chinese firms and suggests that investors are worried that Evergrande won't be the last major Chinese company to run into trouble:

An Evergrande default could leave China with a diminished position in the global economy. China counted for 27% of global economic growth in 2019 and was the only major economy to keep growing through 2020. This kind of growth, Xi seems to have decided, is not as important as growth that is directed by the Chinese Communist Party.

Millions of Chinese households would likely see their property values tank if the company fails. That could spark a pullback in spending and drag on China's economic expansion. But even more importantly, if China shifts its paradigm, the rest of the world's economy will have to adjust.

For decades, western companies have maximized profits by moving manufacturing to China, where it's been much cheaper thanks to make products from microchips to toys to clothing. China's crackdown on its corporate sector is part of a wider decoupling with the west, especially the US, that got under way under the Trump administration and has largely continued with Biden in the White House. When China suddenly halted the largest IPO in history last fall, bankers and hedge funds in New York lost a big payday. If Xi is serious about going further in this new direction, the decoupling should only intensify, and American companies will have to find new (and more expensive) manufacturing partners. CEOs seem reluctant to face that less profitable future.

In addition to the negative global impact, Miller says those developments could hurt China's own economy. "More state control may be helpful in perpetuating the party's control and messaging in the short run, but it's a recipe for disincentivizing innovation in the medium and long terms."

As for what Xi wants to replace the old regime with, he's been increasingly touting the goal of "common prosperity," a key aspect of which is fighting wealth inequality. It's part of a wider school of "Xi thought," as the Chinese leader increasingly consolidates power, having been named the party's "core leader" in September 2020.

This August, the party's central committee wrote that "the strength of the Party and the strength of socialism with Chinese characteristics are attributable to the fact that Marxism works." It's starting to look like China will be much more, well, communist.

Just last July, after Xi's crackdown began in earnest, Autolycus Advisory's Dominick Donald told Foreign Policy, "The canary has died. Get out of the fucking mine shaft and tell your mates to leg it too." Other analysts told the magazine at the time that western CEOs were unwilling to hear bad news about China. Evergrande is an even bigger dead canary, and the mine shaft is changing dramatically.