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“Similarly, the Chinese cannot be blamed for being suspicious that the United States and the West might be choosing inflation as a means of defaulting on debt, especially given that U.S. policymakers seem committed to avoiding any risk of deflation— which implies taking all the risk with inflation. And they wonder, what if the inflation rate the industrial- ized world needs to resolve its debt kills or severely damages emerging markets along the way? China cannot be blamed for fearing the normal conse- quences of inflation: higher prices. Nor can they be blamed for being paranoid. By one measure, China is being defaulted upon, encircled, and threatened on multiple levels. One cannot really be surprised that China may respond to their rising duress using what-ever means necessary.”

K. Philippa Malmgren

Commentary & Analysis

Copper & Aussie: A nasty statistic from China

There has been much talk about the risk embedded inside the Chinese Shadow Banking System; a system that has grown extremely large. According to an estimate from K. Philippa Malmgren, appearing in the winter edition of The International Economy, “China Under Attack,” she writes:

China’s shadow banking system seems to have grown by the size of the entire U.S. financial system in the last year [2013] alone.

Yikes! That’s a lot; I don’t care who you are.

And recently, what was being billed as “China’s Lehman moment,” one of the Shadow Banking System trusts—Credit Equals Gold Number 1—was teetering on the brink of bankruptcy, but it was bailed out at the last minute by “an unknown backer”, according to Miss Malmgren.

It seems there are many of these investment vehicles in trouble in China. We don’t really know because transparency is not a word which translates well into Chinese at the moment.

But here (in bold below) is what I found to be the really scary statistic from Miss Malmgren’s piece:

The problems are by no means solved. Some 43 percent of all of China’s trust products come due in 2014 and 80 percent mature before 2016. Most are collateralized by property or raw materials such as iron ore or copper. It has been said that at least 40 percent of the iron ore and a similar amount of the copper in storage within China’s ports serves as collateral for these trusts. Obviously, the collateral is not worth what it was during the boom, so cash calls are in play. The next spot of trouble came on February 7, 2014, when “Songhua River #77 Shanxi Opulent Blessing Project,” which was backed by iron ore, failed to repay investors the nearly ¥300 million it had raised from them. There will be more such problems given that China’s shadow banking system seems to have grown by the size of the entire U.S. financial system in last year alone. In the main, the fast-growing, highly leveraged financial system has been used to fund more and more building and infrastructure projects with dubious cash flow-generating ability.

Copper as collateral for loans when there is growing concern Chinese housing outside the major cities is massively oversupplied. The stories abound, I won’t reiterate. But I will show you the copper chart and then overlay the Australian dollar chart so you can see why some of the bigger players are long-term bears on the Aussie….

Copper Futures Weekly:

Copper futures versus AUD/USD Weekly: Not exactly tightly correlated as before, but it seems the underlying dynamic to push both prices lower is the same.

Happy Friday!