Is China's Financial System in Trouble?

03/17/2014 12:01 am EST


Jim Jubak

Founder and Editor,

There have been a series of negative data points out of China and MoneyShow's Jim Jubak explains why this may mean larger problems down the road.

What’s starting to worry me is not just that we’re getting a piece of bad news about China that might indicate their stresses in the financial system, but we’re getting a lot of different pieces of bad news, from a lot of different parts of the system, that suggest a, kind of, systemic stress. If you think about it, in the last, oh, say, month or so, we’ve had worries about liquidity in the markets when the People's Bank of China drew down its supply of yuan, we’ve had the first ever Chinese corporate debt default; a solar company, a relatively small one, but the first ever time a bond in the corporate bond market went bad.

Now, what we’re getting is stress that seems to be coming in a strange way from the copper sector. Copper prices have plunged in this one-day period—three days that ended on March 12, we had about a 9% fall in the global price of copper. Copper is usually related to estimates of economic growth and that’s, of course, the worry that China’s economy is going to slow. Really, what this is most directly tied to is, again, stress in the Chinese financial system that a lot of traders and speculators were buying copper, not for any use, but because they could get a loan against the copper and then taking those dollar loans, doing an interest rate arbitrage, they’re getting relatively low rates on those, and then investing it in things like Chinese real estate.

You had a huge, huge upswing in China’s imports of copper in January, about a 53% increase year-to-year from January ‘13 to January ’14, and that’s extraordinary, because you’ve got a situation where the Chinese economy certainly isn’t picking up strength, so where was this stuff going? Well, it was sitting in warehouses. The Shanghai Future Exchange reported a huge amount of copper building up in the warehouses that it tracks. It doesn’t track all of them, so it was probably only about one-third, but we’re talking about tons and tons and tons of copper that’s sitting there as guarantees for loans without any real use in the Chinese economy. The worry here, of course, is that once the underlying bet starts to go bad, if it does, people are going to dump copper onto the market, so that the price of copper would go down. As the yuan has weakened recently, as Chinese real estate has shown some signs of being not as great a bet as it was, you’ve had people saying, “Oh okay, well, maybe I ought to sell my copper, maybe I ought to cover my loan.” At least, that’s the worry, and that would drive down prices further. I think that’s what going on right now, that worry about that is what’s driving prices down.

That’s actually not the worst thing that I can imagine coming out of this. The worst thing would be some actual bankruptcies, defaults, et cetera, by traders who wind up having invested in real estate and betting on the unidirectional yuan, as they only can ever go up, and now can’t cover their loans, so they might actually have to default on a loan, you might see some of that, and that’s the last thing the Chinese system needs, because now you’re looking at a situation where oh, you’ve got corporate bond defaults, you’ve got copper-based defaults, you’ve got bad debts building up, you’ve got a huge amount of corporate get that needs to roll over, and you sort of look at this and go, “Okay, how many things can go wrong in the Chinese system before we get some kind of ripple effect that turns into a wave?” That’s really what I’m worried about right now. That’s what I’m looking at and that's what all this different, uncorrelated—seemingly—news makes me think about.

This is Jim Jubak for the Video Network.