China Commodities Fraud: The Global Implications

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By John Richardson

An eerie calm has descended over financial and commodity markets with volatility at a record low.

The calm is eerie because it reminds us of the build-up to September 2008.

Back then, not one single mainstream economist saw the sub-prime-led collapse coming and at the moment, the same feels as if it applies to problems in China’s real-estate sector.

The catalyst for what happened after September 2008 was, of course, the collapse of Lehman Brothers.

On this occasion, the catalyst looks as if it will be the unwinding of  fraudulent “collateral trades” that are tied into real estate deals in China.

Financial and commodity markets are buoyant and lacking in volatility because of the consensus view that a global economic recovery is firmly in place, and, even if it isn’t, everyone seems to think that the world’s big central banks will always come to the rescue.

The problem is that the most important central bank in this particular financial cycle – The People’s Bank of China – won’t come to the rescue if collateral trades start to unwind, as China has to push-ahead with economic reforms.

“One leading analyst told the blog last week that he believes the new leadership are targeting a 30% fall in prices, in order to clear up the mess,” wrote fellow blogger Paul Hodges, in this 2 July blog post.

“If that is true, a lot of collateral loans will end up being under water.

“And a lot of commodities will come rushing back onto the market in a potentially quite disorderly manner

“In turn, this has the clear potential to trigger a major financial panic outside China.

“The issue facing us is very simple.  China has been buying 40% of world copper supplies, two thirds of world iron ore and large percentages of most other commodities.

“If a large part of this volume was actually used to finance the property bubble, as looks more and more likely, then there is trouble ahead once investors wake up and start to rush for the exit.”

We think that polyethylene, polypropylene and methanol volumes could also be involved in these collateral trades.

And perhaps, as this South China Morning Post story indicates, aromatics are  involved, too. The newspaper refers to an investigation into a suspected fraud involving 4,000 tonnes of “mixed aromatics” (we are guessing that this  is mixed xylenes)  at the port of Tianjin in China.

When people are desperate, as many property creditors and developers are right now in China, they will use any financial tool – even tankers full of methanol and MX that they have probably never traded in before – to try and minimise their losses.

Here is another thought: If the trade finance abuse extends to chemicals that are difficult to transport and store, such a methanol and MX, what does this say about the scale of the problem in polymers? Polymers are, of course, easy to store and move around.

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