How China's Rehypothecated "Ghost" Steel Just Vaporized, And What This Means For The World Economy

Tyler Durden's picture

One of the key stories of 2011 was the revelation, courtesy of MF Global, that no asset in the financial system is "as is", and instead is merely a copy of a copy of a copy- rehypothecated up to an infinite number of times (if domiciled in the UK) for one simple reason: there are not enough money-good, credible assets in existence, even if there are more than enough 'secured' liabilities that claim said assets as collateral. And while the status quo is marching on, the Ponzi is rising, and new liabilities are created, all is well; however, the second the system experiences a violent deleveraging and the liabilities have to be matched to their respective assets as they are unwound, all hell breaks loose once the reality sets in that each asset has been diluted exponentially.

Naturally, among such assets are not only paper representations of securities, mostly stock and bond certificates held by the DTC's Cede & Co., but physical assets, such as bars of gold held by paper ETFs such as GLD and SLV. In fact, the speculation that the physical precious metals in circulation have been massively diluted has been a major topic of debate among the precious metal communities, and is the reason for the success of such physical-based gold and silver investment vehicles as those of Eric Sprott. Of course, the "other side" has been quite adamant that this is in no way realistic and every ounce of precious metals is accounted for. While that remains to be disproven in the next, and final, central-planner driven market crash, we now know that it is not only precious metals that are on the vaporization chopping block: when it comes to China, such simple assets as simple steel held in inventories, apparently do not exist.

From Reuters:

Chinese banks and companies looking to seize steel pledged as collateral by firms that have defaulted on loans are making an uncomfortable discovery: the metal was never in the warehouses in the first place.

This means that in an economy in which the creation of liabilities, and pledging of assets took place at a furious pace in the past 5 years, nobody really knows just what the real state of credit creation truly was. What is 100% certain is that as a result of this revelation, the GDP number of the country, which is and always has been a derivative of credit formation and expansion (and heaven forbid contraction), is massively overrepresenting what it is in reality, and that the Chinese economy has been expanding at a far slower pace if defined not only by the creation of liabilities, but by matched assets. Most importantly, it means that every single Renminbi in circulation is impaired as a country-wide liquidation event would see huge losses by every creditor class. It also would mean, naturally, zero residual value left for the equity.

And just like that the Chinese growth "miracle" goes poof... as does its steel first, and soon all other commodities (coughcoppercough) that served as the basis of "secured" liability creation.

Reuters continues, even if the punchline is already known:

China's demand has faltered with the slowing economy, pushing steel prices to a three-year low and making it tough for mills and traders to keep up with payments on the $400 billion of debt they racked up during years of double-digit growth.


As defaults have risen in the world's largest steel consumer, lenders have found that warehouse receipts for metal pledged as collateral do not always lead them to stacks of stored metal. Chinese authorities are investigating a number of cases in which steel documented in receipts was either not there, belonged to another company or had been pledged as collateral to multiple lenders, industry sources said.


Ghost inventories are exacerbating the wider ailments of the sector in China, which produces around 45 percent of the world's steel and has over 200 million metric tons (220.5 million tons) of excess production capacity. Steel is another drag on a financial system struggling with bad loans from the property sector and local governments.


"What we have seen so far is just the tip of the iceberg," said a trader from a steel firm in Shanghai who declined to be identified as he was not authorized to speak to the media. "The situation will get worse as poor demand, slumping prices and tight credit from banks create a domino effect on the industry."

Ultra-rehypothecation 101:

Police have arrested an employee from Baoyang Warehouse in Shanghai and are investigating documentation for steel stocks that the employee issued to a trading firm, said an official with the surname Ou at Baoyang. Baoyang is owned by China Railway Materials Shanghai Company Limited.


The trade firm used the stocks more than once as collateral to obtain loans, said an executive at Shanghai Minlurin, another trading firm that had steel stocks in the warehouse. The receipts used were for steel worth around 380 million yuan ($59.96 million), the executive said.


Similar cases have prompted some trading houses to temporarily halt transactions related to warehouse receipts, disrupting China's steel business, traders said.

If the above makes readers queasy, it should: after all rehypothecation of questionable assets is precisely what serves as the backbone of that critical component of the shadow banking system: the repo market, where anything goes, and where those who want, can create money virtually out of thin air with impunity as long as nobody checks if the assets used for liability creation are actually in the system (and with JPM as the core private sector tri-party repo entity, secondary only to the Fed, one can see why this question has never actually arisen).

In the meantime, the entire Chinese economy is unraveling:

Banks, too, are giving less credit against warehouse receipts.


"Fake warehouse receipts have become a problem for some banks and because of this, many banks have boosted monitoring of existing stocks at warehouses and temporarily stopped accepting steel stocks as collateral for loans," said a Shanghai-based branch manager from a Chinese bank who declined to be identified as he was not authorized to speak to the media.


Steel mills and end users rely heavily on trading firms to keep steel flowing from producers to consumers. Steel traders often buy consignments with full payment, ensuring cash flow to the mills. End users can buy small volumes from the traders, more convenient for them than the big volumes the mills sell.


Industry sources estimated cases that have already come to light account for about 5 billion yuan ($787.50 million) of bad debt in Shanghai, one of China's biggest steel trading centers.


At another warehouse, a logistics unit of giant steelmaker Baosteel rented a small office to a company called Shanghai Yiye Steel Trade Market Management Co Ltd. Documents were forged stating Yiye was the owner of some of the steel stored in the warehouse, said Wang Xueying, the spokeswoman for the unit called Shanghai Baosteel Logistics Co Ltd.


Yiye used the documents in dealings with two companies, China Railway Harbin Logistics and Wuhan Iron Yitong, the spokeswoman said.


The two companies came to the warehouse to collect the stocks only to find that Yiye did not own the materials, she said. The case is still under investigation, she added.


Nobody answered telephone calls to Yiye made by Reuters to request comment for this story. Both China Railway Harbin Logistics and Wuhan Iron Yitong declined to comment when contacted.

In conclusion we can only add that we hope none of this comes as a surprise to our regular readers: we have been warning for years that i) the inventory of the world's credible assets is literally evaporating in absence of technological efficiency and CapEx spending (which is also the reason for the ECB's endless lowering of collateral requirements) and ii) illegal rehypothecation of assets, which infinitely dilutes claims on real assets, can and will lead to total losses even for investors who thought they had strong collateral backing.

We now know that this has been happening in China with the most critical component of its economic growth miracle: steel. We will soon discover that all other assets: stocks, bonds, commodities (including gold and silver) and finally cash (think deposits) have been comparably rehypothecated and criminally commingled. The end result will be the most epic bank run in world history, which incidentally is precisely what the central banks are attempting desperately to delay as much as possible by generating excess inflation to "inflate" away the debt, leading to rematching of finite assets and virtually infinite liabilities. Alas, in a world in which credit-money liabilities are in the quadrillions, and in which the real assets are in the tens of trillions, only hyperinflation can seal the deal.

Or, in other words, lose-lose.

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CPL's picture

Bubble time!!!

Newsboy's picture

"Steel Your Face"


strannick's picture

China was content with accepting Treasuries in return for their labors. No surprize they were also content with paper steel -which doesnt have near the tensile strength- instead of real steel. Maybe they wrongly interpreted the Google translation of ''steal''. Just as warehouse receipts dont equal ''steel'', so GLD, gold certificates, allocated, unallocated doesnt equal ''gold"

CPL's picture


It means IOU's, were backed with IOU's, that were backed by IOU's backed by Steel that doesn't exist.


Well, there it is.  I usually only mock that strategy in jest, some fool actually did it.



Wouldn't be funny if all that gold they've been buying has been written against the vapour steel?

surf0766's picture

Monster Pawn Stars !!!!!!!!!!!!!!!!!!

mjcOH1's picture

You have to applaud their initiative.   Five years ago they were plowing their excess capacity into empty cities that no one will ever live in.   At a certain point they saw the inefficiency in that, skipped the actual production phase, and started filling imaginary warehouses with imaginary steel.   And think of the greenhouse gas emission savings!

Stuart's picture

somebody needs to check the ozs supposedly backing up GLD and SLV.   

CPL's picture

You don't get it.  This calls into question of any delivered asset shipped to China, from China, near China.  What was the trade backed with exactly and who ends up with the stolen asset.  Because that's what it is at that point.  Theft.  Biggest gold and silver robbery ever.

They could have underwritten the delivered Gold and Silver with illusionary steel against the cash backed asset of GLD and SLV.  Hell, the bonds they've been buying, how were they collaterilzing it.  Imaginary steel in empty warehouses.

Chinese firecrackers on a string going off one by one.  Pop pop pop crack pop crack...until the big finale.


Then that in turn triggers GLD/SLV clients to review their inventory and find the same thing in their pocket as they were walking in.  Nothing.  Shell game.



smlbizman's picture

alright this is nothing new...back in the late 80's early 90's,,,this guy selling trailors, if your park has dirt roads, or mobile homes , if your streets are asphalt and a manufactured home if your park has a pool.....was floor planning units to many lenders at one time...this guy was rolling..helicopter, yacht etc.....and swear his company was "johns homes" , yea i know...he was located in delaware....the party eventually ended and john went to jail for quite awhile...the only difference is he went to jail...

Michael's picture

What's that thing I'm always saying that I have informed you thusly of?

Pinto Currency's picture


This article shames China.

Prepare to be attacked when China is finished with Japan.

If not ZH directly, then your at least  your proxy servers.


hiramspiral's picture

Wait, what happened?  I don't speak ground-up hamburger--please elaborate. 

hiramspiral's picture

...not that ground-up hamburger is entirely unintelligible. 

bilbert's picture


I'm glad I swallowed my sip of wine before I read this, as it would have sprayed the walls.

This must be the Moore's Law of Finance!


Pool Shark's picture



Aaaaand,... it's gone!



Au Member's picture

maybe all that steel was actually there but then turned to dust.

where have I seen that before, oh yeah here:

Michael's picture

It was an orbiting SDI defense satellite that did them in along with explosives, so no one would figure it out, the two WTC Towers. Building 7 was explosives only, that's why they had to get rid of it in a hurry, along with all the Dot-Com evidence.

Just like this Iranian facility done late last year, note the absence of creators and other things;

Satellite Images Show Iranian Missile Base Destroyed

Au Member's picture

I can't comment on orbiting satellites as I don't have any evidence of this. But the evidence presented by Dr Wood is compelling and is the only scientific methodology I have seen used to derive an explanation as to what happened. She doesn't speculate as to who or how, just merely what occured which is important as a discerning and inquistive mind can easily be derailed by trolls into who, why etc. Just get the book and see what happened in all it's stark horrendous reality and that is enough to shake the foundations of our conditioned reality. I've owned the book for 2 years and only just mustered the courage to read it.

Sheeple Shepard's picture

Aaaaand, was never there!

Philippines's picture

Southpark really hit the bullseye on that episode.

So.. What would happen if China decides to inspect all collateral around the world, in particular with any "things" the USA liened to China, existent or not? 

CPL's picture

GASP...they did, thieving little shits.

They leveraged their steel against delivered gold.  Holy's going to be a weird ride now.



slyhill's picture

I keep tellin anyone listening - use your education: kite credit cards 'till your're an 800 w/100k in revolving credit, payoff your "student loans," buy PMs. Enjoy.

tenpanhandle's picture

yeah, that's the ticket.  Become a slimeball crook because others are doing it.

Michael's picture

Fair Isaac will be destroyed!

JackT's picture

Or even better, leveraged rehypothicated steel for rehypothicated gold.

Kayman's picture

When Muddy Waters outed Sino Forest, they should have outed the entire country.  Larceny forever.

Michael's picture

Repo 105

What's that thing I'm always saying that I have informed you thusly of?

CPL's picture

Lehman with real assets of delivered gold backed by nothing but a fuck you.  I wonder what was underwriten with bullshit as well.  Anyone take a look at facebook angel investors yet?


Well played China, well played.


Cocktail anyone?  Grab a deck chair, beer's in the fridge, coffee's on the stove, snacks are in the fridge.  This is going to be a hell of a show.

Michael's picture

I got extra popcorn.

blindfaith's picture want to see an investment backed by a fuck you, then you need to look into the "on line education' fraud that is being 'discovered', nation wide.    Robo-signing of diplomas by teachers that never saw the student and had no idea their names were being used by the 'universities'.  Worthless degrees 'earned' by students that can't pass 5th grade math, construct a readable sentance, etc.

Just ask Michael ( below) what the ( yes, another one) scandal in Florida is over K12.  And the great Governor of Florida has, once again, stone waledl any investigation of the crimes of friends and supporters.  Florida....the shinning example for the great USA for integrity.

knukles's picture

Actually, it's not that uncommon.  Ask any commercial loan officer.  People attempt to pledge single assets multiple times against new loans all the time... called fraud.
Remember the Tea Pot Dome Scandal!
Was done abundantly in MBS/CLO/CDO land as well.


RockyRacoon's picture

I was wondering when someone was going to come back down to earth.  This shit ain't new, just a  new player.  It's common procedure in the commercial real estate markets.   Probably less now that we have appraisers with their wits about them now, but it's not totally gone -- just more clever.  As a real estate broker all thru the 1980s I can just shrug my shoulders at this thing the Chinese think they invented.  The real sparks will fly as we uncover the Wall Street angle!  Now those guys are geniuses at this.

Almost Solvent's picture

The twist that China may have hit on is getting physical gold & silver delivered based on fake collateral. 


Why bother with real estate when you can get physical gold & silver for free?

Melin's picture much gold does China have again?

blindfaith's picture

as much as they want you to believe, and not an ounce more!!!!

dexter bland's picture

You can bet a lot of the copper sitting in Shanghai bonded warehouses is for just this purpose. Why use copper (or any other metal) for collateral when you could use cash, real estate or something else? Because it is easier to use metals fraudulently.

Fraud is driving the commodities boom.

1000924014093's picture

To badly paraphrase Bertrand Russell-- It's IOU's all the way down.

Ookspay's picture

LMFAO, If I steal your steel will it still be steal

Harbanger's picture

There's an old joke about the family iron and steel business, where the mother irons and the father steals.

Kayman's picture

If you ever had to work with Chinese steel, you would know "paper steel" is of the same quality.

Chinese Steal.  That is what the country is all about.

tenpanhandle's picture

I thought everyone knew where the Chinese steel was.  Its stored in American landfills, for petes sake.

Dr. Sandi's picture

I believe that's the 'In Ground Steel Reserve' you're talking about.

sgt_doom's picture

Fantastic blog posting, TD but.....

Was there ever really any there there ? ? ?

I mean, would they have offshored all those jobs from America, Japan, UK and Eurozone to China if the labor hadn't been the cheapest 'cause the country was the poorest???

They got the jobs, and others received their purchases of endless financial instruments of debt.

DTCC's Stock Borrow Program (SBP) for naked short selling, unlimited number of naked swaps (unconnected credit default swaps), unlimited number of commodity futures contracts, unlimited number of investors per hedge fund, rehypothecation to the max, and LIBOR manipulation (plus those finer points of securtizations of re-securitizations of re-securitizations, .....).

Is there any there anywhere .....?

redd_green's picture

haven't you read enough ZH to know by now that China in now way traded treasuries for "their labors"?

malikai's picture

One thing you can be sure of about the Chinese rehypo thing is that some people will hang.

Henry Hub's picture

Actually, they shoot them in the back of the head. The family has to pay for the bullet and their organs are sold. Chinese justice is s bit rough by our standards, but it is an effective deterrent.