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  • China: WSJ Joins the Wenzhou Story

    Copper, rebar or soybeans.  It doesn't matter what the underlying "collateral" is, it's all inventory financing.  Same story, different country, different decade.  Been happening, will happen more.  The question is degree.

    China's asset prices, fueled by credit growth, is the greatest any economy has ever seen.  No economy has ever been able to justify twenty years of work to purchase housing.  None.



    From WSJ


    China Copper Hunger Fades
    Demand Has Fallen, and Market Players Cite Speculators Being Reined In

    By ANDREA HOTTER in London and YUE LI in Shanghai

    LONDON—For a clue as to why copper is lagging behind many other commodities, investors could look to Wenzhou, China.

    A recent government crackdown on predatory lending in the coastal city has upended a flourishing market: borrowing on margin to buy and then resell copper.

    The business of flipping copper in China has grown in recent years amid easy credit and soaring copper prices. The market helped create a virtuous circle for copper, as rising prices enticed more people to borrow and make bullish bets.

    Many of these buyers are small-business proprietors who are parlaying their profits into the copper trade. While some used letters of credit issued by banks, others sought financing from underground lenders like those in Wenzhou.

    The government move in Wenzhou has attracted interest from other copper traders, many of whom see the case as an example of what may be in store. It also comes as China more broadly is seeking to raise the cost of borrowing.

    While it is difficult to pin down the prevalence of speculative trading, market participants say it has a big impact on prices.


    Imaginechina/Zuma Press

    A worker hoists copper coils in Jiangsu, China, earlier this year. Imports in 2011 have declined 39%.

    Copper futures plunged by roughly a third from the end of July to Oct. 20, in part because of China's attempts to rein in lending, traders say. Since then, they have recovered but are down 21% this year. On Monday, copper for November delivery finished at $3.4855 a pound on the Comex division of the New York Mercantile Exchange. Crude-oil futures are up 7.4% this year.

    "There is a liquidity crunch in China for speculative trades," and that is pressuring prices, said Bart Melek, senior commodities strategist at TD Securities.

    The copper decline is a reminder of how sensitive the commodities world is to the whims of Chinese buyers, and, more importantly, to the health of the Chinese economy. Investors and analysts are focused on demand within China for everything from copper to cotton to corn. And even a marginal move one way or the other can have a big impact on prices.

    China is the world's biggest consumer of copper, using it for goods ranging from wiring in electronics to glaze used to coat ceramics.

    Some have long argued that speculative bets in China have distorted the signals that copper consumption and imports typically send about the strength of manufacturing sectors.

    "People were looking at copper imports and making assumptions that China was growing faster than it actually was," says Simon Van Den Born, who heads London Metal Exchange-traded metals at commodities and futures broker Marex Spectron. "Now, the risk is that falling copper imports will signal a weakness that's not really there and potentially set the market up for a big fall."

    So far this year, imports of refined copper have plunged 39%, according to China's customs service. They fell 8.3% in 2010, after more than doubling in 2009. The declines are largely being attributed to the reduction in lending to speculators.

    A big focus remains on copper inventories in China. Although there is no hard data on exactly how much copper is stored in warehouses, analysts forecast that stockpiles will decline this year due to a fall in speculative activity.

    But the copper industry also is feeling the pinch of reduced credit, said Simon Hunt, an industry consultant. The copper going into China isn't "destined for furnaces, because the overall level of business is not good," Mr. Hunt said.

    A revival in copper prices isn't out of the question, especially if China moves to loosen lending again or embark on economic stimulus, said Leon Westgate, an analyst with Standard Bank.

    But, so far, there is little sign China will change course, and Mr. Westgate thinks it is unlikely there will be any monetary easing this year. "As a result, we continue to believe that rallies in copper should fade," he said.


    Nov 28 1:59 PM | Link | Comment!
  • China: Delusion and Imports

    Lying to yourself.  It's the worst of crimes.  Lying to yourself allows for outrageous behavior and outrageous mistakes.  China is lying to itself.

    The comment below, "to avoid a property market bubble" is laughable.  Avoid?  Housing prices are twenty to fifty times annual income and they think they've avoided the bubble?  Complete delusion.  Which allows for them to believe that they are in a "soft landing".

    China will also seek to boost imports.  Really?  With what?  Credit from lending out rebar?  or maybe soybeans?  (see China Property Market: Doomsday Scenario Revealed)

    Lying to yourself.  Delusion.  Chinese business leaders conveyed the message that worries about a sharp downturn in the economy were unfounded.

    A credit contraction could never happen in China.  It can happen in the U.S.  It can happen in Europe.  It can happen in Russia and Mexico.  It can't ever happen in China.





    Hu Pledges More China Imports as IMF’s Zhu Sees ‘Soft Landing’

     Nov. 14 (Bloomberg) -- China’s President Hu Jintao pledged to boost imports as the world’s second-biggest economy heads for what the top Chinese International Monetary Fund official said was a successful downshift from inflationary growth.

     IMF Deputy Managing Director Zhu Min and China’s National Economic Research Institute Director Fan Gang yesterday told the Asia Pacific Economic Cooperation forum in Honolulu that the economy was heading for a “soft landing” as growth slows. They cited lower inflation and less bad debt at banks, and what Fan said were timely measures to avoid a property market bubble.

     “It has become ever clearer that the Chinese economy is moving to a soft landing,” Zhu said. “The Chinese economy today is really moving to an inflection point, moving to more services and capital-intensive economy.”

     Zhu and Fan, speaking on the same panel, said economic expansion would slow from the 9.1 percent growth in the third quarter, with Fan saying sustainable growth in gross domestic product was about 8 percent. Their forecast contrasts with some observers including hedge fund manager Jim Chanos, who has predicted since at least February 2010 that the property market will slump, saying that China is on a “treadmill to hell” because of its reliance on real estate for growth.

     Helping Others

     Hu on Nov. 12 said China will seek to boost imports in part to help stimulate economies around the world.

     “We must be firmly committed to maintaining growth and promoting stability, with a special emphasis on ensuring strong growth in order to add momentum to the economic development in the Asia Pacific and beyond,” Hu told APEC business executives. China will “focus more on increasing imports while maintaining a stable level of exports.”

     China, the world’s biggest exporter, has been the target of critics for its large trade surplus with the U.S., the world’s biggest importer. China’s overall trade surplus has been declining as imports, including Porsche Automobil Holding SE’s Cayenne sport-utility vehicles and iron ore from Rio Tinto Plc, have increased along with rising incomes and a nationwide surge in construction spending.

     China’s exports rose at the slowest pace in almost two years in October as Europe’s deepening debt crisis crimped demand. Overseas shipments from the world’s second-largest economy rose 15.9 percent from a year earlier, customs bureau data released Nov. 10 showed. The trade surplus was $17 billion, lower than all 24 estimates in a Bloomberg News survey. Imports climbed a more-than-forecast 28.7 percent.

     Rising Yuan

     A rising yuan makes imports cheaper and China’s exports more expensive. China’s currency has risen about 8 percent in nominal terms since the country ended a two-year peg to the dollar in June, 2010. In real terms the yuan has risen even more because inflation in China is higher than in the U.S. The yuan rose 0.06 percent to 6.3424 in Shanghai on Nov. 11, according to the China Foreign Exchange Trade System.

     China’s inflation cooled in October, home sales fell and industrial output grew at the slowest pace in a year, adding pressure for measures to support growth in the world’s second- biggest economy.

     Consumer prices rose 5.5 percent from a year earlier, the least in five months, the statistics bureau said Nov. 9. Housing transactions slid 25 percent from September, the bureau’s data showed.

     Unfounded Worries

     Chinese business leaders conveyed the message that worries about a sharp downturn in the economy were unfounded.

     Bank of China Ltd. Chairman Xiao Gang said the bank had controlled lending to local-government investment vehicles, whose ability to repay debt is a source of concern for the government and international investors. He told reporters at APEC that the lender, the country’s third-biggest by assets, had controlled lending to local governments. The bank said it had 531.5 billion yuan ($83.8 billion) in loans to such entities at the end of June. Xiao said much of the debt was to highway companies that had steady revenue streams from tolls.

     “Their toll collections are a guarantee that they’ll repay their debt,” he said on Nov. 12.

     A government audit released in June said that more than 6,000 local government financing vehicles around the country had total debt of 10.7 trillion yuan as of the end of last year. Nearly a third of China’s local government financing vehicles are losing money, according to a study published in September in the magazine of the country’s official bond clearing house.

     Still, Hu said “unbalanced, uncoordinated and unsustainable development poses a major challenge to China.” The country’s wealth gap is rising, food prices rose 11.9 percent in October from a year ago and investment makes up more than 40 percent of the economy.

     “It will be very difficult to say for the time being that the Chinese consumer will save the world,” Zhu said. “China invests too much and it consumes too little.”

    Nov 28 1:58 PM | Link | Comment!
  • China Property Market: Doomsday Scenario Revealed…nario-revealed/economic-news-commentary/

    An article on Reuters, combined with other news and our knowledge and analysis, has revealed to us just how the doomsday scenario in China, specifically the property market but eventually the whole country, will play out.  Our last trip to Shenzhen, China, was in July of 2011, just a few months ago.  We believe our research and insight is current.  Now, let’s go back a few days.

    On November 6, we wrote Gimme Credit or Gimme Death: Death is Winning in China.

    The China Credit Problem has started in Wenzhou, but it won’t end there.  We’ll soon be hearing more stories like this.  How else can people afford housing at 20 to 50 times annual income?  The amount credit creation has to be insane, not just in the property market, but in every other credit leveraging market as well.

    Sentence-by sentence:

    The China Credit Problem has started in Wenzhou, but it won’t end there.

    Someplace is always ground zero.  You don’t have 90 bosses fleeing the city and two committing suicide unless there’s an enormous problem.  The Bloomberg article that talked about Wenzhou, only hinted at problems across the country.  What was obvious is that the credit practices in Wenzhou were clearly going to be duplicated, or at least replicated in some fashion, elsewhere.

    We’ll soon be hearing more stories like this.

    It only took four days till the Reuters article.  The next forty should be real interesting.

    How else can people afford housing at 20 to 50 times annual income?

    When you think about the financing needed to purchase housing at twenty times annual income, it becomes clear that each individual is overly stretched.  Twenty times income is a 5% cost of capital.  If you’re entire paycheck only goes toward rent, you still only generate a 5% return on your purchase.  Since people need food, clothing, transportation, etc., it’s impossible to believe anything close to that is possible.

    The amount [of] credit creation has to be insane, not just in the property market, but in every other credit leveraging market as well.

    Since it’s impossible to finance a 5% cost of capital return on property when property costs twenty times annual income, the only way to be able to afford the financing cost is if a large down payment is made.  We have heard that buyers do in fact put substantial down payments on property.  What’s unclear is how they obtain it.  We’ve heard that 40% is common.  But the question remains, how?  Putting down 40% is eight times annual income.  Even if an individual or family had a 50% savings rate, it would still take them 16 years to accumulate the capital needed for a property purchase.  (Yes, maybe less with compounded returns on their savings, but not that many years less).  So does it make sense that the buyers of property in China have all been saving for the past sixteen years?  We don’t believe that.  We believe that there has to be other significant sources of credit creation that individuals are leveraging in order to come up with these down payments.  It is this precise thought that is confirmed and detailed in today’s Reuters article, “China commods gamble heightens property threat”.

    Sitting in China's copper and steel warehouses is a hidden risk to the world's second-largest economy -- banks' indirect exposure to a property market that is showing signs of stress.

    Since late 2010, Chinese entrepreneurs and state firms have used trade loans to import goods such as copper and soybeans, which they have then quickly sold or used as collateral for further loans, skirting government credit curbs.

    Many lent that cash in informal markets, earning as much as 70 percent interest -- a nice return given that bank fees and commissions on letters of credit (NYSE:LC) can be as low as 3 percent for established companies, and allow payment some six months down the line.

    Remember what we also said four days ago, “How does anyone think that they can afford 1% per month?  What’s worse is some were paying 7% per month!”

    What’s 7% per month?  Its roughly 84% per year depending on the intra-period compounding.  This is how some people were earning “as much as 70%”.

    The Reuters article continues:

    While Beijing has moved to clamp down on the practice, banks are still exposed to an unexpected batch of bad loans should a slump in property prices and sales coincide with another sharp fall in commodity prices.

    "Banks are already heavily exposed to the property sector and if a chunk of their trade finance books is also exposed to real estate, they could be in for a double whammy," said Stanley Li, China banking analyst at Mirae Assets.

    "The end-game may be very nasty if higher financing costs, a property price correction and a slump in commodity prices trigger waves of defaults," said Li, who has researched extensively into the risk of this cash-for-commodity phenomenon in China.

    Yesterday, we wrote China: Housing – October Home Sales Drop 25% and detailed this thought:

    But the Chinese has [have] a different problem.  In China there are hundreds of millions of people that have yet to buy housing.  There are also hundreds of millions of people that have already bought housing.  One group needs lower prices; the other detests the thought.  How is the government going to explain to hundreds of millions of people that the sum total of your life’s work is zero?

    “How is the government going to explain to hundreds of millions of people that the sum total of your life’s work is zero?”   On any metric, the China Property Market bubble will burst and dwarf all other bubbles.  What’s particularly worse about this bubble is the loss each individual will take relative to their entire lifetime earnings.  If housing prices drop from twenty times income to four times income, it’s not that the price decline is 75%.  It’s that the decline represents sixteen years of annual income for that individual.  Sixteen years of your life has just evaporated.  How does any government or society deal with that?

    Back to Reuters:

    Some housing projects in Shanghai have already lowered prices by around 30 percent in recent weeks and some developers have run into problems repaying their debt, according to local media reports.

    Thirty percent declines?  Developers that can't pay their bills?  Does this sound like a healthy market?  Is this a market that can be saved with an infusion of equity when prices that were twenty times income are now “only” fourteen times income?

    In yesterday’s Bloomberg article, “China’s home prices retreated for a second month in October”.  Prices have only started to decline in the last 60 days, yet Shanghai housing projects are slashing prices 30%?  The country hasn’t begun to adjust to these new prices.  Data points like these are outliers, for now.

    Again, back to Reuters:

    Though it will try to keep the market steady, Beijing risks holding on too long to its tightening policies aimed at reining in home prices and inflation even as it faces slowing economic growth and strong external headwinds.

    Should the traders who have borrowed through trade finance start to lose money on their property deals or not be repaid what they lent to others to speculate on property, that could potentially be a catalyst for a chain reaction of defaults, analysts say.

    "You'll need a convergence of a few events to unleash this can of worms: a sustained, sharp fall in copper or steel prices that coincides with a large amount of these trade-related loans maturing," said the loans executive from the foreign bank.


    There is no reliable data on the extent of such trade financing -- inventories of commodities can be anything from poorly catalogued to a state secret -- but what is sure is that it is widespread enough that it has expanded beyond copper into the markets for steel and soybeans.

    So everything can be used as collateral to obtain credit.  Everything.  Sounds like lending standards have gone out the door.

    With steel prices still in the doldrums and a significant portion of the country's 610 million tonnes of "rebar" inventories used as collateral, it is now the weakest link in this elaborate scheme.

    Rebar is the collateral.  Rebar.  The cheapest steel to manufacture.

    For steel, which is largely domestically traded, merchants tend to either use their warehouse stocks as collateral for loans, or to turn to acceptance bills, an equivalent to a letter of credit for domestic markets.

    "The proceeds obtained from financing by steel traders are usually used in other sectors such as property and underground loans," said a trader with a Shanghai-based steel firm, the owner of which is from Wenzhou, which has become a hub of informal financing that has started to see defaults.

    There’s that Wenzhou reference again that Bloomberg mentioned four days ago.  Here is the direct link from steel/ soybean/ whatever financing to the property market.

    Some of the smaller players have already started to be weeded out.

    "There have been more than 15 steel trading firms, with most of the owners from Fujian province, being forced to shut down as their financing chain was broken this year," said a trader based in Wuxi, Jiangsu province who was in direct contact with one of the firms that closed.

    Firms are out of business.  Not because of trading steel, which was their business, but because of leverage.  Lending.  Thinking there was easy money to be made as a bank.

    "Around three steel trading firms have been sued by banks now, as they used the proceeds from financing for extending private loans, but now can't get those loans repaid," the trader said.

    Banks can’t get loan repayments because the collateral they thought they had, the steel, has been leveraged and used as collateral to others.


    The practice extends to agricultural commodities.

    Faced with tepid domestic demand, some soybean crushers in Shandong province have also used LCs to import beans, then sold the beans into the market, even at a loss, to get cash that they can channel back into the underground banking system.

    So the business you’re in is now the loss leader for the banking entity you’ve become.

    A lot of that money poured into Wenzhou, a city in eastern Zhejiang province known for savvy entrepreneurs that has now become the center of concerns over systemic defaults in such informal lending networks.

    Good old Wenzhou again.  Waiting out the next forty days to see where else this is happening.

    Lin Shunfeng, a futures manager at Shenyin & Wanguo Securities who travelled to Jiangsu, Anhui, Hubei and several other provinces to research the topic, said the practice was most prevalent around June, when the market was oversupplied and port stocks were filled to the brim.

    He estimated that around 10-15 percent of the 6 million tonnes of soybean stocks held at ports in June were used as a tools for cheap yuan.

    Based on soybean prices at that time, those stocks would imply at least 1.23 billion yuan was rolled on to underground loans, but the actual value could have easily been in the tens of billions as firms could use the cash received as a leverage for larger sums.

    Sounds like banking 101.  Only difference here is the velocity of money is off the chart.  Lever up your cash and then use the leverage to obtain more leverage.

    It is difficult to estimate the scale of such funds involved in the steel and copper markets, but the figures are clearly much bigger, as traders well connected with warehouses often are able to use the same batch of cargo to repeatedly get bank loans. Some could even inflate the value of their stocks to land fatter loans.

    So now the collateral has been pledged to multiple lenders, which means no one has any collateral.


    This ingenuity in circumventing capital controls has not gone unnoticed in Beijing.

    In August, the government included deposits for bank acceptance bills and letters of credit -- previously deemed as off-balance-sheet assets -- for calculating their reserve requirement ratio.

    The effect was instant. Trade financing costs quickly tripled for some mid-sized companies and the move mopped up an estimated 800-900 billion yuan ($125-$141 billion) of deposits from the banking system.

    So in August the government clamped down on these lending prices and in September and October property prices declined, with Shanghai housing projects dropping 30%.  Coincidence or cause and effect?

    Recent earnings reports from Chinese banks also showed that the volume of such loans issued in the last quarter had dropped, while a steady decline in Shanghai warehouse stocks suggests fewer firms were able to use this sort of backdoor trade financing.

    De-leveraging has started.  How has that worked out in the US?

    Some bigger trading firms that themselves have been extending credit have also been forced to tighten up.

    "We've been lending out money to peer trading companies and using their cargoes as collateral. But as credit conditions have become tighter and tighter, we have increased our interest rates from 15 percent earlier this year to around 22 percent now," said a Shanghai-based steel trader.

    They’ve increased the interest rates instead of asking for more collateral.  This is a dangerous mistake.  As we see from above, the issue is the collateral, much more than the rate.

    "We are also only lending to a select few ore trading companies that we are familiar with and find trustworthy."

    Trustworthy?  They wouldn’t use the same collateral for two different loans?  How would you ever know?

    Although that is good news for the larger economy, it could be the reverse for commodity markets since it means China's ability to scoop up global copper supplies during any price routs will be limited.

    "Going forward, the sort of buying would be more rational and driven by actual demand instead of a means to get cash," said Helen Lau, an analyst at UOB-Kay Hian in Hong Kong.

    Proof that China has been hoarding commodities.  They haven’t been hoarding because of future construction projects, they’re hoarding as a means to extend or get credit.  When this ends, can the unit demand for copper, soybeans, etc. in the future be anywhere near what it’s been in the past?

    “It's bad for sellers but not a bad thing in the eyes of Beijing, which has long been worried about commodity speculation at home driving up raw materials prices for its own people."

    Thank you Reuters, Carrie Ho and Ruby Lian for an excellent article.

    In Gimme Credit four days ago, we wrote:

    China is going to need their currency reserves.  The Europeans are barking up the wrong tree.  There’s no money there.

    China will need to use their currency reserves as an equity infusion into their own economy.  This is why they can’t lend it to Europe.   The need is greater within the borders of China.

    Finally, just two days ago, we wrote, what is our unwavering conclusion - China: Property Prices have Started the Fall:

    Making massive allocation bets into assets that are massively overpriced will yield an economic disaster.  Yes, a disaster.  China won’t experience a slowdown of growth; they won’t experience a recession; they won’t experience a depression.  No the economic future of China is a pure, unmitigated disaster.  A depression will be something they hope for.

    This is why China will not and cannot support the EU.  China will need every last dollar of reserves to mitigate the coming economic storm, and even that won’t be enough.  There will be a day when the U.S. needs to support China, not the other way around.

    Who’s saying that?

    Nov 28 1:57 PM | Link | Comment!
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