How China's Commodity-Financing Bubble Becomes Globally Contagious

Tyler Durden's picture

"Marubeni [the world's largest soybean exporter to China] is deluded in thinking that payments will come once the cargoes have sailed," is the message from an increasing number of liquidity-strapped Chinese firms, "If they take these cargoes, some could go bankrupt. That's why they choose not to honor the contracts." As we explained in great detail here, this is the transmission mechanism by which China's commodity-financing catastrophe spreads contagiously to the rest of the world. A glance at the Baltic Dry is one indication of the global nature of the problem (and Genco Shipping's $1 billion bankruptcy), but as Reuters reports, "If buyers cannot resolve the issue, they may also cancel future shipments."

 

Reuters notes that China's soybean imports in the first quarter jumped 33.5 percent, a record for the quarter and industry sources see a rush of cargoes in the second quarter. The rise comes amid an increasing use of soybeans in financing trades to secure credit.

Traders estimate more than 10 million tonnes of soybeans, out of China's imports of 63.4 million tonnes last year, are imported for financing annually.

And the lack of liquidity and forced losses means China's buyers ain't paying...

Chinese buyers may default on a further 1.2 million metric tons (1.32 million tons) of soybeans worth about $900 million being shipped from the United States and South America, to avoid incurring huge losses in a depressed local market, the country's top soy buyer said.

 

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Honoring these deals would cause Chinese buyers to incur a loss of as much as $7 million per shipment,

 

"If they take these cargoes, some could go bankrupt. That's why they choose not to honor the contracts," Shao said.

Of course, this odd 'beggars are choosers' almost monopoly of buying pressure dry-up means Chinese buyers can play hard-ball...

"Most of the cargoes were delivered by the seller before receiving letters-of-credit and buyers are unwilling to pay now because they will suffer massive losses," said Shao, speaking from a hotel suite he uses when in Rizhao in this eastern province.

 

"If buyers cannot resolve the issue, they may also cancel future shipments."

 

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Some Chinese commodity buyers have previously threatened to default, or cancel cargoes, to force sellers to take lower prices.

 

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"Marubeni is deluded in thinking that payments will come once the cargoes have sailed," said an industry executive also based in Shandong, who declined to be identified

 

With so many shipments at risk of a default, Chinese buyers now have a upper hand in bargaining for lower prices.

 

"Most of the cargoes will eventually be sold to China. This will force sellers to renegotiate prices, which will benefit buyers,"

And the lower prices will only exacerbate liquidity problems as collateral value tumbles on the soybean-backed loans.

And this means counterparty risk is rising broadly - which means haircuts (or Letters of Credit) soar, collapsing liquidity conditions and leading to a further vicious tightening cycle...

Banks, once content to rake in profits from the lending, have been spooked by growing losses at crushers and trading firms and have begun tightening credit.

 

"They are asking for more a higher deposit to opening a LC (letter of credit) nowadays; before it was set at 10 percent of the contract value but banks have gradually raised the level to between 20-30 percent," said an executive at a trading firm.

 

Industry sources said the hike has severely crimped traders' cash flow, with weak demand leaving them with high inventory they cannot liquidate fast enough.

As we explained previously,

While apologists of China's collapse have been quick to point out that China's credit collapse would be largely a domestic issue, with little foreign creditor exposure at either the public debt, or private - corporate - debt levels, one thing nobody can deny is that if and when Chinese trade routes grind to a halt, the downstream impacts would be devastating, and spread like wildfire as the offshore supply chain is Ice 9'ed.

And sure enough that is what Reuters reports above is happening... which means only one thing...

We explained precisely this a few days ago in "What Is The Common Theme: Iron Ore, Soybeans, Palm Oil, Rubber, Zinc, Aluminum, Gold, Copper, And Nickel?" As briefly noted above, these are all the commodities that serve as conduits in China's numerous Commodity Funding Deals. Only no more.

Which means that far form merely crushing exporters who suddenly are dealing with Chinese importers who have torn apart contracts, obviously with no recourse, suddenly China's entire "hot money" laundering infrastructure (which as explained over the weekend, has gold performing an even greater role than copper) is about to collapse.

And when the counterparties of China's hundreds of billions in CCFDs decide to also get out of Dodge and unwind these deals (amounting to hundreds of billions in notional), only to find the underlying commodity has not only been re-re-rehypotecated countless times and has been sold, then there is truly no way of saying what happens next.