The thing about any debt-funded Ponzi scheme is that it is like a great white: it has to keep moving, or else it dies. The problem with China is that for the past decade, in order to fund the most rapid period of industrialization and modernization in history, it has been moving at an absolutely torrid pace. And by moving we mean creating credit, which always takes us back to our favorite chart comparing the US and Chinese financial systems, that of total bank assets in the two countries. Spot which one is poised for a horrendous crash the second credit creation slows down from the breakneck pace of $3.5 trillion in inside money creation per year…
Still, what China has successfully done in recent years, is maintaining the facade that all is well in the economy, despite ever sharper gyrations in its credit markets, gyrations which have finally put enough pressure on the economy to send China’s core driver of economic growth, fixed investment which accounts for over 50% of GDP, sharply lower, something we explained a month ago when we observed that the Chinese commodity crash is not only continuing but accelerating at a record pace, and in fact as we reported overnight, Singapore iron ore futures just tumbled to a record low.
And where this slowdown was seen best of all, is in China’s critical coal industry, critical because not only is China the world’s largest consumer of coal, not only does coal provide the bulk of China’s electric production, generating nearly 70% of the country’s electricity, or because the industry employs so many workers, but because it is to many the best harbinger of what else is taking place within China’s resource and commodity space. And what is taking place is very bad, as we showed in early September:
Maybe most importantly, the Chinese coal industry is one of the places where the country’s shadow banking funding structures, including wealth products and trusts, is most pervasive.
Also, keep in mind that as a result of Beijing folding instead of holding bankrupt companies to task, it has simply delayed the inevitable. Because this is what BofA said back in February:
We believe that during April to July the market may see many trust products threatening to default, especially those related to coal mines. By our estimate, the first real default most likely could happen in May with a Sichuan lead/zinc trust product worth Rmb140mn. This is because the product is relatively small (so the government may use it as a test case), the underlying asset is not attractive (so little chance of 3rd parties taking it over) and we also have heard very little on parties involved trying to work things out. Whether this will trigger an avalanche of future trust defaults remains to be seen and this presents a key risk to the market in our opinion.
… it’s still possible that many of the upcoming cases in Apr-July may get worked out one way or the other. Nevertheless, as we believe that many of the underlying assets of the trust products are insolvent, it’s a matter of time that many products will ultimately default, in our view. Various bail-outs will only delay the inevitable.
Of course, nothing was worked out, and only yet another record credit injection in Q2 prevented a credit crunch that could and would have rivaled what happened in June of 2013 when overnight repos soared to 25%.
Instead, what has happened, is that the fundamentals in the coal space have gotten even worse, the cash flow is even weaker, if it exists in the first place, while the funding mechanisms are more stretched than ever.
But the one place where the feces are finally hitting the fan, is in the companies themselves, as kicking the can for the past year has done nothing to resolve the underlying issues. And as a result, here is what is going on in China, courtesy of SCMP:
Wang Xianzheng, the chairman of the China National Coal Association, told an annual meeting of the Coal Industry Committee of Technology at the weekend that more than 70 per cent of the country’s coal miners were losing money and had cut salaries.
Translated: widespread wage deflation, in a country where M2 is expected to grow at a double digit pace…
And the really bad news:
About 30 per cent of the industry’s miners had not been able to pay their employees on time and a further 20 per cent had cut salaries by more than 10 per cent, the Economic Information Daily, a Xinhua-affiliated newspaper, reported on Monday.
Due to weak economic conditions, coal output fell 1.44 per cent year on year in the first eight months of this year to 2.52 billion tonnes, while sales dropped 1.62 per cent to 2.4 billion tonnes, the association’s figures show.
Coal inventory last month stayed above 300 million tonnes for a 33rd month.
China’s main coal ports recorded an 8.3 per cent year-on-year decline in inventory at the end of last month, and the national import volume fell 27.4 per cent year on year to 18.86 million tonnes, the association’s figures showed. In July, Wang called on coal-mining firms to reduce output by 10 per cent. Leading listed miner China Shenhua Group has cut its output target for this year by 4 per cent, while rival China Coal Energy has trimmed its target by 10 per cent.
Clearly, they did not.
And the result is that nearly a third of the coal industry doesn’t know if and when it will get paid, while over two thirds are on the verge of being fired. We are talking millions and millions of workers. Correction: millions of soon to be angry workers. And if those angry workers make their way to Beijing or Shanghai, what China’s SHIBOR, repo rate, or any other made up financial metric is, will be the least of anybody’s worries.