Critical Observer

CHINA DEFAULTS TO POP WORLD’S BIGGEST BOND BUBBLE

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<span style="font-family: "trebuchet ms" , sans-serif; font-size: x-large;">Once China began to mark an exceptionally difficult transition from a smokestack economy to a consumption and services-led model, those who were aware of how the country had gone about funding years of torrid growth knew what was likely coming next.</span></div>
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<span style="font-family: "trebuchet ms" , sans-serif;">Years of borrowing to fund rapid growth had left the country with a sprawling shadow banking complex and a massive debt problem and once commodity prices collapsed – which, in a bit of cruel irony, was partially attributable to China’s slowdown – some began to suspect that regardless of how hard Beijing tried to keep up the charade, a raft of defaults was inevitable.</span></div>
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<span style="font-family: "trebuchet ms" , sans-serif;">Sure enough, the cracks started to show earlier this year with <a href="http://www.zerohedge.com/news/2015-01-01/and-2015-starts-bang-first-chinese-default-year-hits" style="background-color: transparent; border: 0px; box-sizing: inherit; color: #194e8e; font-size: inherit; font-stretch: inherit; font-style: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; padding: 0px; text-decoration: none; vertical-align: baseline;">Kaisa</a> and<a href="http://www.zerohedge.com/news/2015-04-21/first-chinese-state-owned-firm-defaults-its-bonds" style="background-color: transparent; border: 0px; box-sizing: inherit; color: #194e8e; font-size: inherit; font-stretch: inherit; font-style: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; padding: 0px; text-decoration: none; vertical-align: baseline;">Baoding Tianwei Group</a> and as we documented last month, <strong style="border: 0px; box-sizing: inherit; font-size: inherit; font-stretch: inherit; font-style: inherit; font-variant: inherit; line-height: inherit; margin: 0px; padding: 0px; vertical-align: baseline;">if you’re a commodities firm, there’s a 50-50 chance you’re not generating enough cash to service your debt:</strong></span></div>
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<span style="font-family: "trebuchet ms" , sans-serif;">There’s only so long this can go on without something “snapping” as it were because even if Beijing intends to perpetuate things by continuing to engineer bailouts (e.g. <a href="http://www.zerohedge.com/news/2015-10-19/chinas-glencore-state-owner-miner-and-steel-trader-avoids-default-last-minute-intere" style="background-color: transparent; border: 0px; box-sizing: inherit; color: #194e8e; font-size: inherit; font-stretch: inherit; font-style: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; padding: 0px; text-decoration: none; vertical-align: baseline;">Sinosteel</a>), that will only add to the deflationary supply glut that’s the root cause of the problem in the first place and ultimately, Xi’s plans to liberalize China’s capital markets aren’t compatible with ongoing bailouts so at some point, the Politburo is going to have to choose between managing its international image and allowing the market to purge insolvent companies.</span></div>
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<span style="font-size: inherit; font-style: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit;"><span style="font-family: "trebuchet ms" , sans-serif;">On Wednesday we get the latest chapter in the Chinese defaults saga as cement maker China Shanshui Cement Group Ltd said it won’t be paying some CNY2 billion ($314 million) of bonds due tomorrow.</span></span></div>
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<span style="font-family: "trebuchet ms" , sans-serif;">Oh, and it’s also going to default on its USD debt and file for liquidation.</span></div>
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<span style="font-family: "trebuchet ms" , sans-serif;">Here’s <a href="http://www.bloomberg.com/news/articles/2015-11-11/china-s-shanshui-cement-to-default-on-onshore-bonds-on-thursday" style="background-color: transparent; border: 0px; box-sizing: inherit; color: #194e8e; font-size: inherit; font-stretch: inherit; font-style: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; padding: 0px; text-decoration: none; vertical-align: baseline;">Bloomberg with more</a>:</span></div>
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<em style="border: 0px; box-sizing: inherit; color: #5b5c5e; font-size: inherit; font-stretch: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; padding: 0px; vertical-align: baseline;"><span style="font-family: "trebuchet ms" , sans-serif;">On Wednesday, the creditors got their answer. <strong style="border: 0px; box-sizing: inherit; font-size: inherit; font-stretch: inherit; font-style: inherit; font-variant: inherit; line-height: inherit; margin: 0px; padding: 0px; vertical-align: baseline;">Shanshui, reeling from China’s economic slowdown and a shareholder campaign to oust Zhang, said it will fail to pay 2 billion yuan ($314 million) of bonds due on Nov. 12, making it at least the sixth Chinese company to default in the local note market this year. Analysts predict it won’t be the last as President Xi Jinping’s government shows an increased willingness to allow corporate failures amid a drive to reduce overcapacity in industries including raw-materials and real estate.</strong></span></em></div>
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<div style="border: 0px; box-sizing: inherit; font-size: inherit; font-stretch: inherit; font-style: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; max-width: 100%; padding: 10px 0px; vertical-align: baseline;">
<em style="border: 0px; box-sizing: inherit; font-size: inherit; font-stretch: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; padding: 0px; vertical-align: baseline;"><span style="font-family: "trebuchet ms" , sans-serif;">Shanshui’s troubles — it will also default on dollar bonds and file for liquidation — reflect the fallout from years of debt-fueled investment in China that authorities are now trying to curtail as they shift the economy toward consumption and services. In the latest sign of that transition, data Wednesday showed the nation’s October industrial output matched the weakest gain since the global credit crisis, while retail sales accelerated.</span></em></div>
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<span style="font-family: "trebuchet ms" , sans-serif;"> <strong style="border: 0px; box-sizing: inherit; font-size: inherit; font-stretch: inherit; font-style: inherit; font-variant: inherit; line-height: inherit; margin: 0px; padding: 0px; vertical-align: baseline;"><em style="border: 0px; box-sizing: inherit; font-size: inherit; font-stretch: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; padding: 0px; vertical-align: baseline;">“Debt wasn’t a problem during the boom years because profits kept growing,” Zhang said last month. “But it’s not sustainable when the economy slows.”</em></strong></span></div>
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<span style="font-family: "trebuchet ms" , sans-serif;"> <em style="border: 0px; box-sizing: inherit; font-size: inherit; font-stretch: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; padding: 0px; vertical-align: baseline;">Shanshui’s total debt load as of June 30 was four times bigger than in 2008, according to data compiled by Bloomberg.</em></span></div>
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<span style="font-family: "trebuchet ms" , sans-serif;"> <em style="border: 0px; box-sizing: inherit; font-size: inherit; font-stretch: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; padding: 0px; vertical-align: baseline;"><strong style="border: 0px; box-sizing: inherit; font-size: inherit; font-stretch: inherit; font-style: inherit; font-variant: inherit; line-height: inherit; margin: 0px; padding: 0px; vertical-align: baseline;">Defaults in China’s local corporate bond market have mounted this year as the economy weakened. </strong>Sinosteel Co. last month failed to pay interest on 2 billion yuan of notes maturing in 2017. Baoding Tianwei Yingli New Energy Resources Co., whose majority holder was until last year the world’s biggest solar panel company by shipments, failed to make a complete payment on a note due Oct. 13.</em></span></div>
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<span style="font-family: "trebuchet ms" , sans-serif;">There’s also a shareholder spat with the chairman going on here, but in the end, this is story fits perfectly with the narrative as laid out above and as we’ve documented on too many occasions to count. This is a perfect storm involving heavily indebted producers whose businesses have become uneconomic in the face of a sharp downturn and efforts to keep them afloat have only served to exacerbate the same overcapacity problem that forced them into de facto insolvency in the first place.</span></div>
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<span style="font-family: "trebuchet ms" , sans-serif;">So where do we go from here? Well, nowhere good and in a sign of things to come, Bloomberg<strong style="border: 0px; box-sizing: inherit; font-size: inherit; font-stretch: inherit; font-style: inherit; font-variant: inherit; line-height: inherit; margin: 0px; padding: 0px; vertical-align: baseline;"> also reports that Yunnan Coal Chemical has some CNY1.31 billion in overdue debt “due to continuous losses and rising financing.” </strong></span></div>
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<span style="font-family: "trebuchet ms" , sans-serif;"><strong style="border: 0px; box-sizing: inherit; font-size: inherit; font-stretch: inherit; font-style: inherit; font-variant: inherit; line-height: inherit; margin: 0px; padding: 0px; vertical-align: baseline;">As <a href="http://www.zerohedge.com/news/2015-10-23/we-now-have-eta-when-biggest-bond-bubble-world-will-burst" style="background-color: transparent; border: 0px; box-sizing: inherit; color: #194e8e; font-size: inherit; font-stretch: inherit; font-style: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; padding: 0px; text-decoration: none; vertical-align: baseline;">we noted</a> earlier this month, a</strong>s of this moment China has <a href="http://www.zerohedge.com/news/2015-10-13/clsa-just-stumbled-neutron-bomb-chinas-banking-system" style="background-color: transparent; border: 0px; box-sizing: inherit; color: #194e8e; font-size: inherit; font-stretch: inherit; font-style: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; padding: 0px; text-decoration: none; vertical-align: baseline;">between $25 and $30 trillion notional in financial and non-financial corporate credit </a>(in China, where everything is government backstopper, there isn’t really much of a difference), about 5 times greater than the market cap of Chinese stocks (and orders of magnitude greater than their actual float), and 3 times greater than China’s official GDP, which also makes it the biggest bond bubble in the world, even bigger than the US Treasury market.</span></div>
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<a data-slb-active="1" data-slb-asset="2022991480" href="http://www.zerohedge.com/sites/default/files/images/user5/imageroot/2015/10/China%20bank%20assets%20Oct%202015.jpg" style="background-color: transparent; border: 0px; box-sizing: inherit; color: #194e8e; font-size: inherit; font-stretch: inherit; font-style: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; padding: 0px; text-decoration: none; vertical-align: baseline;"><span style="font-family: "trebuchet ms" , sans-serif;"><img alt="" height="410" src="http://www.zerohedge.com/sites/default/files/images/user5/imageroot/2015/10/China%20bank%20assets%20Oct%202015_0.jpg" style="border: 0px; box-sizing: inherit; font-size: inherit; font-stretch: inherit; font-style: inherit; font-variant: inherit; font-weight: inherit; height: auto; line-height: inherit; margin: 0px; max-width: 100%; padding: 0px; vertical-align: baseline;" width="600" /></span></a></div>
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<span style="font-family: "trebuchet ms" , sans-serif;">For their part, BofAML thinks this entire debacle could begin to unravel in earnest in about six months and on that note, we’ll once again close with the list of who’s most likely to be next:</span></div>
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<a data-slb-active="1" data-slb-asset="1323653865" href="http://www.zerohedge.com/sites/default/files/images/user5/imageroot/2015/10/blow%20up%20candidates%201.jpg" style="background-color: transparent; border: 0px; box-sizing: inherit; color: #194e8e; font-size: inherit; font-stretch: inherit; font-style: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; padding: 0px; text-decoration: none; vertical-align: baseline;"><span style="font-family: "trebuchet ms" , sans-serif;"><img alt="" height="701" src="http://www.zerohedge.com/sites/default/files/images/user5/imageroot/2015/10/blow%20up%20candidates%201_0.jpg" style="border: 0px; box-sizing: inherit; font-size: inherit; font-stretch: inherit; font-style: inherit; font-variant: inherit; font-weight: inherit; height: auto; line-height: inherit; margin: 0px; max-width: 100%; padding: 0px; vertical-align: baseline;" width="600" /></span></a></div>
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<a data-slb-active="1" data-slb-asset="2107946705" href="http://www.zerohedge.com/sites/default/files/images/user5/imageroot/2015/10/blow%20up%20candidates%202.jpg" style="background-color: transparent; border-image-outset: initial; border-image-repeat: initial; border-image-slice: initial; border-image-source: initial; border-image-width: initial; border: 0px; box-sizing: inherit; color: #194e8e; font-size: inherit; font-stretch: inherit; font-style: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; padding: 0px; text-decoration: none; vertical-align: baseline;"><span style="font-family: "trebuchet ms" , sans-serif;"><img alt="" height="701" src="http://www.zerohedge.com/sites/default/files/images/user5/imageroot/2015/10/blow%20up%20candidates%202_0.jpg" style="border: 0px; box-sizing: inherit; font-size: inherit; font-stretch: inherit; font-style: inherit; font-variant: inherit; font-weight: inherit; height: auto; line-height: inherit; margin: 0px; max-width: 100%; padding: 0px; vertical-align: baseline;" width="600" /></span></a></div>

CHINA DEFAULTS TO POP WORLD’S BIGGEST BOND BUBBLE

Once China began to mark an exceptionally difficult transition from a smokestack economy to a consumption and services-led model, those w...

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BITCOIN: Barclays first UK bank to support BitCoin

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Banks have been poking around bitcoin technology for some time to better understand how it works and how they might use it. Now, they appear to be getting a lot more serious about the digital currency.<br />
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Over the weekend, Barclays announced (paywall) that it would help charities accept bitcoin payments, making it the first UK bank to support the currency. The new feature is a small but important step toward Barclays—or any bank—fully accepting bitcoin.<br />
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Banks across the world have been exploring bitcoin, trying to determine the potential uses for the digital currency and its underlying blockchain technology. While most of these discussions and projects have been private and internal, banks are slowly escalating their bitcoin experiments.<br />
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The New York Times reported last week that 75 employees from 15 different financial institutions held a private meeting at Bank of America to discuss using blockchain technology to revamp the foreign currency exchange market. Bitcoin has a number of advantages for forex trading, including near-instant transfer speeds and a much lower cost structure than current methods.<br />
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Some hurdles remain before banks widely adopt bitcoin and blockchain technology. There’s still a lot of concern that bitcoin is the currency of choice for illegal activity, and banks are worried about more government scrutiny.

BITCOIN: Barclays first UK bank to support BitCoin

Banks have been poking around bitcoin technology for some time to better understand how it works and how they might use it. Now, they app...

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Bitcoin Technology Piques Interest on Wall St.

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Most people still think of Bitcoin as the virtual currency used by drug dealers and shadowy hackers looking to evade the authorities.<br />
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But the innovations that helped turn Bitcoin into the most popular virtual currency are now being viewed as a potentially enormous disruptive force for several industries, including accounting, music and journalism.<br />
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Nowhere, though, are more money and resources being spent on the technology than on Wall Street — the very industry that Bitcoin was created to circumvent.<br />
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“There is so much pull and interest on this right now,” said Derek White, the chief digital officer at Barclays, the British global bank, which has a team of employees working on about 20 experiments that explore how the technology underlying Bitcoin might change finance. “That comes from a recognition that, ‘Wow, we can use this to change the fundamental model of how we operate to create our future.’”<br />
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For people like Mr. White, Bitcoin isn’t just a digital token to use for online purchases. Instead, many of the top minds in finance have come to believe that the software that brought the virtual currency into existence also enables a fundamentally new way of transacting and maintaining records online — allowing people and banks to directly exchange money and assets like stocks and bonds without having to rely on a long chain of expensive middlemen.<br />
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A few banks have gone public with their work, but most of the activity has been happening behind the scenes. At one private meeting, held in April at one of the Manhattan offices of Bank of America, executives from more than a dozen large banks gathered to confidentially discuss how the technology underlying Bitcoin could be used to change foreign currency trading, the largest financial market in the world, according to people who attended the meeting.<br />
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Central banks like the Federal Reserve and the Bank of England have their own teams looking at the technology.<br />
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“A year ago, it was more of an idea,” said Max Neukirchen, the head of corporate strategy at JPMorgan Chase. “Now, it is a real opportunity. You test it and realize that this can play a big role in our thinking about how our own infrastructure will evolve.”<br />
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This is a long way from the derision that many bankers — including JPMorgan’s chief executive, Jamie Dimon — expressed when Bitcoin burst into the public consciousness in 2013, when the price of a Bitcoin was bouncing around wildly in a speculative frenzy that was often compared to the Dutch tulip bulb mania.<br />
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At the time, some large companies like Dell and Overstock announced that they would start taking Bitcoins for online purchases, but few consumers showed much interest in using the digital money to pay their bills, and the furor around Bitcoin largely died down.<br />
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The institutions that are now becoming involved are generally not interested in selling goods for Bitcoins or owning the virtual currency. They are, instead, looking at the network and software that make it possible for Bitcoin to move around the world instantly, and almost free.<br />
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Until now, digital transactions have always gone through some sort of central authority that can move the money and update the records on both sides — as PayPal and Visa do for many online purchases.<br />
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The Bitcoin network, on the other hand, is run by a decentralized network of users who jointly keep track of transactions and update the records in real time, with no single user or company in charge. The records of all transactions are kept on a public ledger — essentially just a big, publicly available spreadsheet — known as the blockchain that is visible to anyone and has, at least so far, proven impossible to tamper with.<br />
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Much of the work being done inside banks, and in other industries, is looking at whether the blockchain technology can be used independently of the Bitcoin virtual currency, which was the first thing to be recorded on the blockchain ledger.<br />
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The music publication Billboard recently wrote about how several start-ups are aiming to use a digital ledger like the blockchain to keep track of musical downloads and distribute the royalties to artists without relying on a central record keeper.<br />
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Vermont’s state government commissioned a study in June to look at how a blockchain could be used as a legal method of record keeping under state law; it is one of several governments, many of them outside the United States, looking at the technology.<br />
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But the most intense work is being done by financial companies like the Nasdaq OMX Group, which has several programmers in Manhattan preparing software that the company plans to roll out this year.<br />
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The Nasdaq software will allow the trading of stocks in private companies, like tech start-ups, on a new kind of blockchain. This will replace the existing system in which private companies issue and trade shares using paper certificates — a process that means that even basic trades can take weeks to complete.<br />
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Beyond the immediate trial, Nasdaq is experimenting with several other markets in which blockchain-like ledgers could be used to make trading faster and cheaper. The work is being overseen by Frederik Voss, who recently shifted from his work in the company’s commodity division to become its top blockchain executive.<br />
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“We believe that blockchain technology holds great promise in allowing capital markets to operate more efficiently while simultaneously providing greater transparency and security, all of which are fundamental to the public interest,” Nasdaq’s chief executive, Robert Greifeld, said in a July call with investors.<br />
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Financial firms first began talking publicly about Bitcoin in late 2013. Back then, though, most of the attention was negative, focused on the speculative aspect of the virtual currency.<br />
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More recently, banks like Goldman Sachs, Santander and BBVA have made their first investments in outside start-ups working on Bitcoin technology, several of which were started by former employees at big banks.<br />
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But the banks have generally been less public about the work they have been doing internally with their own employees. At Citigroup, for instance, there are six different in-house experiments, building software that harnesses the blockchain technology, according to people briefed on the company’s work. In one test, the bank has created its own virtual currency, Citicoin, that employees can experiment with.<br />
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Aside from Nasdaq’s project, there is much debate about where the technology is likely togain its first real world use. At Barclays, some of the 20 internal experiments — most of them conducted at two Barclays offices in London dedicated to the technology — are looking at ways to use the blockchain to speed up and lower the cost of consumer payments, to compete with credit cards and direct money transfers.<br />
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But bankers generally say that most of the work is aimed at changing the systems that big Wall Street traders and investors use to buy and sell sophisticated assets like syndicated loans and corporate bonds.<br />
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Because any innovation in this area would require the cooperation of multiple banks, the banks have had joint meetings to discuss how they could work together, often led by outside start-ups looking to provide the software.<br />
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One of the most advanced of those conversations has been coordinated by a start-up known as R3Cev that is led by a former Wall Street executive, David E. Rutter. R3Cev has put together models for how banks could trade foreign currencies on a communally maintained spreadsheet like the blockchain, according to people briefed on the project. It was R3Cev that convened the April meeting at Bank of America, which was attended by more than 75 people from 15 financial institutions, these people said.<br />
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This can seem like rather esoteric business, but these are the markets where huge amounts of money turn over each day, and these markets influence the profits of the largest financial institutions. For instance, more than $3 trillion changes hands each day on the foreign currency market.<br />
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For many bankers, the question is not if the technology is put to use but when. Mr. Neukirchen, at JPMorgan, is one of many bankers who expect that it will take a few years for the first significant use of blockchain technology to gain traction. Mr. White at Barclays expects it even sooner, in the next year.<br />
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The prospect of banks capitalizing on the technology can be disappointing to early Bitcoin adherents, many of whom were drawn to the technology because it provided a way to move and store money that did not rely on banks.<br />
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Many in the financial industry hope they can find a way to use the blockchain concept — what is often referred to as a distributed ledger — without using the blockchain associated with Bitcoin.<br />
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Although the bankers working on the idea disagree on how this will happen, they show surprisingly little disagreement on whether it will happen. One of Goldman’s top Internet analysts, Heath Terry, said in a recent company podcast that “the whole blockchain tech behind Bitcoin has massive implications for really any kind of asset — and the ability to transfer ownership of digital goods.”<br />
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“It’s hard to see a world where that blockchain technology doesn’t end up changing the way we think about asset ownership,” he said.<br />
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<span style="background-color: white; color: #333333; font-family: nyt-cheltenham-sh, georgia, 'times new roman', times, serif; line-height: 12px;">By </span><span class="byline-author" data-byline-name="NATHANIEL POPPER" itemprop="name" style="background-color: white; color: black; font-family: nyt-cheltenham-sh, georgia, 'times new roman', times, serif; line-height: 12px; text-decoration: none;"><a href="http://topics.nytimes.com/top/reference/timestopics/people/p/nathaniel_popper/index.html" rel="author" style="background-color: white; color: black; font-family: nyt-cheltenham-sh, georgia, 'times new roman', times, serif; line-height: 12px; text-decoration: none;" title="More Articles by NATHANIEL POPPER">NATHANIEL POPPER</a> of the New York Times</span>

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