Saturday, 5 September 2009

'China Syndrome' Derivatives Meltdown ? Ominous

Not a happy weekend topic, but another cycle of misery appears to be upon us: state-mandated default for reasons of convenience.

The Chinese are reportedly of a mind unilaterally to allow state-owned entities to default on OTC commodities derivatives (presumably out-of-the- money forwards or swaps entered into when prices were high last year).

There is some history here: way back in 1994 a Chinese firm called Minmetals defaulted on derivatives contracts and Lehmans, its US counterparty, tried but failed to get them enforced in the courts (finally only settling out-of-court in 2002).

Since then, China has preferred to be seen playing by Big Boy's Rules and, when in the last few years Chinese companies have made stonking derivatives losses, they have swallowed them. It would be a serious turn of events if they are now to be selective as to which contracts they honour - with geopolitical overtones potentially making the enforecability issues raised by famous cases like Orange County, Gibson's Greetings and Hammersmith & Fulham, appear rather provincial. A China-Syndrome meltdown in derivatives is the last thing the system needs right now.

This one's got our full attention. Next week we'll also take a look at Euro-interference with banks redeeming and paying coupon on their bonds ... or not ...



Demetrius said...

If this is correct things could start to get very difficult in unpredictable ways. Clearly, quite a few will get hurt, and some badly. But who and where?

Steven_L said...

I think it's going to take some bigger, badder and uglier news than this to save my FTSE short now Nick, but I live in hope.

measured said...

Who wants one of those US banks to be your counterparty now? The Chinese know fear is very effective at making people fall into line. I suspect this is part of their campaign (and you can't blame them as they now realise they do have to invest in US dollars to keep the world economy going) to make the US more accountable for the growth of the US budget deficit.

Why should the US dollar be the reserve currency of the world if the US cannot conduct their affairs in a responsible manner. US banks are guilty of misleading many professional investors to bear the losses. The Chinese are standing up for themselves. I doubt others will follow though despite the G20 timing. What happened to 'my word is my bond'? Or the bunfight for bonuses, come to that.

Anonymous said...

It appears that Ted Butler may have solved the problem in respect of precious metals.

If this is true we can look forward to quite a rebound in metals prices, and mining equities, perhaps more than has happened already.

It seems that AIG (again) was involved.

If the above is correct, it may be that the intention to default is nothing more than specific contracts that in retrospect, and with the knowledge of hindsight, were fraudulent from the beginning.

It would be interesting to know who the six international banks are.
Probably JPM and HSBC are 2 of them.

Interesting how things unravel, and significant how parties in possession of, or suspecting the above, have remained mute.

Anonymous said...

On the other hand.....

Anonymous said...

This situation seems bizarre.

Here we have the Chinese state sanctioning the state companies default on derivatives that effectively suppress the prices of particular commodities, creating a jump in prices.

We also have the Chinese State encouraging their own population to purchase those commodities for investment purposes.

Assuming the state is honest towards it's own population, (???) does this result from an opinion that the state now has satisfactory levels of those commodities?

The publicly acknowledged reserves of Gold Bullion held by China fall far short of those, (as a %) held by western states, (if the western states are honest), so where does this take us?

Have the Chinese suddenly acquired a vast increase in gold, if so where from? Even 400 tons from IMF would not be enough.

(I note $50B donation to IMF basket from China recently, presumable to aid increase of SDRs)

Is this a further warning shot from China, aimed at western currency printing?

Fitting this into the global picture is difficult. Something is missing.

Nick Drew said...

Demetrius - near-term, it's anyone who is marking-to-market any in-the-money derivs with Chinese counterparties (= mainstream banks + commodity houses); medium-term it's wherever the dominos fall. In my experience, although hedgies have piled into commodities, they tend to sleeve through banks and are unlikely to be the direct counterparties - though banks may have recourse to them, I suppose.

Steven - OK I shall try harder!

welcome, measured
can't blame them - I know what you mean, they will be plotting a very strategic response & who knows how it will play out

Anon-with-the-links - keep coming, we like your links!

@ 9:02 - I can't pretend to be able to read the Chinese either (though I'm ready to take a crack at the Russians) - and we know they are plotting something ... and probably something with a 50-year perspective, which is one of the reasons we hopelessly tactical westerners find them difficult

anon-with-the-links :>) said...

Here's another link that may explain

electro-kevin said...

"Why should the US dollar be the reserve currency of the world if the US cannot conduct their affairs in a responsible manner ?"

10 supercarrier battle fleets count for something.

Sebastian Weetabix said...

I fear this is always a possibility when doing business in or with China. From personal experience, we have had signed contracts relating to supply of raw materials which simply have not been honoured. Why? Someone else came along later & offered better terms, so they took it - therefore no material to send to us. It is not a level playing field in China and rule of law counts for little.

Anonymous said...

Ah yes, the paper tiger is going to allow Chinese companies to default on debts held by US financial institutions. Which will give the US all the moral high ground it needs to respond in a similar manner.

Who do you think will lose that particular game?

Anonymous said...

Anon @ 11.25am

Interesting play.

How do you see the US response?

Anonymous said...

OOps, pressed the button too quick.

To continue, .....if the bullion banks slam PMs back down, it aids Chinese purchases of such, and maybe an intent to create a COMEX default.

Which way will the US go? A completely different arena?