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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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Mon, 09/17/2012 - 19:32 | 2805439 donsluck
donsluck's picture

Apparently not.

Mon, 09/17/2012 - 19:55 | 2805522 Henry Hub
Henry Hub's picture


Mon, 09/17/2012 - 23:29 | 2805993 tenpanhandle
tenpanhandle's picture

either the steel gets delivered or the fraudster does.

Mon, 09/17/2012 - 19:56 | 2805527 Dadburnitpa
Dadburnitpa's picture

That'd be perfect for Corzine.

Mon, 09/17/2012 - 20:35 | 2805656 malikai
malikai's picture

Who would want his organs?

Mon, 09/17/2012 - 20:58 | 2805707 Dadburnitpa
Dadburnitpa's picture


Mon, 09/17/2012 - 23:32 | 2805998 neidermeyer
neidermeyer's picture

My bologna has a first name , it's JOHN , My bologna has a second name it's Corzine...

Mon, 09/17/2012 - 19:59 | 2805528 Dadburnitpa
Dadburnitpa's picture


Mon, 09/17/2012 - 19:00 | 2805337 mjcOH1
mjcOH1's picture

And we can be nearly as sure it won't be the right people.

Mon, 09/17/2012 - 20:10 | 2805571 malikai
malikai's picture

Slaughter the monkey to scare the pig.

Mon, 09/17/2012 - 20:41 | 2805668 toady
toady's picture

I always say that the other way...

Slaughter the pig to scare the monkey.

Tue, 09/18/2012 - 05:01 | 2806234 malikai
malikai's picture

Think of the context.

Tue, 09/18/2012 - 16:26 | 2808382 bigfire
bigfire's picture

The actual phrase goes like this: Kill the Chicken to scare the Monkey.

Mon, 09/17/2012 - 19:22 | 2805403 EnglishMajor
EnglishMajor's picture

Steel your money.

Mon, 09/17/2012 - 23:26 | 2805986 El Oregonian
El Oregonian's picture

Sounds like their steel was involved in a terrible boating accident... OR somebody ended up stealing the steel!

Mon, 09/17/2012 - 17:40 | 2805117 bank guy in Brussels
bank guy in Brussels's picture

This is really a profound turning-point ZeroHedge article actually ...

The whole concept of a 'receipt for goods held on your behalf' is really dead, all around the world ... vapourised ...

'Give me a loan, and I'll give you a receipt for full collateral held safe and secure in a warehouse in China!'

Groucho Marx foresaw this decades ago ...

« I'll give you my personal note for 90 days ... and if I don't pay you back, you can keep the note. »

Mon, 09/17/2012 - 17:55 | 2805176 CPL
CPL's picture

I love Duck Soup.

Mon, 09/17/2012 - 18:00 | 2805192 centerline
centerline's picture

Is the mechanism by which everything will be vaporized.  Skips right past the hyperinflation run-up and goes directly to fail.

Mon, 09/17/2012 - 18:07 | 2805211 AL_SWEARENGEN

"Precious metals are financial assets like currencies, T-bills, and T-bonds; they trade in the multiples of a hundred times the underlying physical"


-Jeffrey Christian (aka Baghdad Bob) Testifying before the CFTC 03/25/2010

Mon, 09/17/2012 - 18:09 | 2805215 Eally Ucked
Eally Ucked's picture

Lets load up on iron investments then!

Mon, 09/17/2012 - 18:23 | 2805254 AllThatGlitters
AllThatGlitters's picture

Sprott just filed for his latest offering:  Sprott Physical Steel Trust (PHSTL)


Mon, 09/17/2012 - 19:10 | 2805368 Manthong
Manthong's picture

And the metal will be redeemable after acquiring units equivalent to 50,000 tons.

That might be a bit much to stow in the back of the Jeep, though.

Mon, 09/17/2012 - 21:07 | 2805728 Ness.
Ness.'s picture

IOU's are not realised as payment.  


No Hedge.

Mon, 09/17/2012 - 18:39 | 2805296 Son of Loki
Son of Loki's picture

"Physical possession is 10/10th of the law," my Dad used to say.

Mon, 09/17/2012 - 19:21 | 2805401 Piranhanoia
Piranhanoia's picture


Groucho saw his money disappear with the stock market crash.  He had purchased mass quantities on margin.  He was real lucky.  They just started making sound pictures and the brothers were ready.


Mon, 09/17/2012 - 20:26 | 2805626 Ness.
Ness.'s picture

I'm anticipating the pop, we all know is coming.  


But this "Popped" into my mind.  Not the Weasel?  Cause pop pop goes the weasel, and the weasel goes... POP!




Poppin' corn and just waiting for the "finalee".


Mon, 09/17/2012 - 21:22 | 2805772 Buck Johnson
Buck Johnson's picture

Look at MF Global and the rest, we are going to see something that will make the great depression look like a 1% down day in the stock market.  Instead of China put in the US, we are in the same boat and it's alot worse.  Once the dominoes start falling, it will be a mad dash out the door.

Mon, 09/17/2012 - 17:26 | 2805056 ghengis86
ghengis86's picture

What is "Corzined" in Mandarin?

Mon, 09/17/2012 - 17:29 | 2805072 CPL
CPL's picture

Man that travel through turnstile sideways going to bang cock.

<rim shot>


I got nothing...

Mon, 09/17/2012 - 17:30 | 2805074 Randall Cabot
Randall Cabot's picture

Is this why China stocks were down over 2% last night while the rest of Asia was up?

Mon, 09/17/2012 - 17:33 | 2805088 CPL
CPL's picture

They haven't got an Algo division yet...note yet.

Tue, 09/18/2012 - 01:08 | 2806122 TIMBEEER
TIMBEEER's picture

The Chinese HFT botnet is down for some reason. People should visit more x-rated sites to fix this capacity issue.

Mon, 09/17/2012 - 22:12 | 2805869 chump666
chump666's picture

Looks like what all our indexes will look like once war breaks out.  Repatriation flows. 

Days of Iraq/Afghanistan quagmires are over.  Next blowups are standup fights, country to country.  So if you are about to go to war, you pull your funds/projects...everything out of the country that looks like it's about to go all out war.

Asia is still selling.

Mon, 09/17/2012 - 20:07 | 2805565 krispkritter
krispkritter's picture

  "_________ _____ _  ___" Translation: "Invisible Thief Go Poof"

Mon, 09/17/2012 - 20:33 | 2805648 JohnG
JohnG's picture

Line up, ready, aim, BANG.

Mon, 09/17/2012 - 21:24 | 2805779 Death and Gravity
Death and Gravity's picture


Mon, 09/17/2012 - 17:27 | 2805058 roadsnbridges
roadsnbridges's picture

Surprise, bitchez!


(Shoulda gone for Remington Steele.)

Mon, 09/17/2012 - 17:27 | 2805062 Rainman
Rainman's picture

Does this mean commies are still lying ?.......i thought the Chinese were honest capitalists now.

Mon, 09/17/2012 - 17:29 | 2805069 roadsnbridges
roadsnbridges's picture

Let me check with OBlameO....sure there's a video about that somewhere.

Mon, 09/17/2012 - 17:29 | 2805070 Tyler Durden
Tyler Durden's picture

They are merely doing what every other "developed world" capitalist is doing: lying and making stuff up.

Mon, 09/17/2012 - 17:32 | 2805082 CPL
CPL's picture

Ignore the man behind the iron curtain I am the great and powerful Hu Jintao...skratch that...ZeMin Jiang.

Mon, 09/17/2012 - 18:39 | 2805295 dick cheneys ghost
dick cheneys ghost's picture

Pass the Sweet and Sour Shrimp mother fucker

Mon, 09/17/2012 - 18:46 | 2805313 CPL
CPL's picture

Here I got the soup you ordered... Cream of Sum Yung Guy.  Waiter told me it was a little salty but said you don't mind.  Now get your purse Nancy...time to blow this Popsicle stand.


<rim shot>


Be sure to tip your waitress.

Mon, 09/17/2012 - 22:35 | 2805907 Rylie
Rylie's picture

One more time for the cheap seat at the back.......

Tue, 09/18/2012 - 00:04 | 2806059 CPL
CPL's picture

Go...and never darken my towels again!

Mon, 09/17/2012 - 17:49 | 2805157 falak pema
falak pema's picture

what does this chinese situation do to the assets and profits of a global steel oligarch like Mittal; is it good or bad for him, given that steel prices are falling, as is demand?

This could be contagion big time.

Mon, 09/17/2012 - 17:54 | 2805171 CPL
CPL's picture

It's still a physical asset, because the steel just vanished and the Chinese have a habit of killing executives that do bad business.  I'm going to guess someone is going to go have to go buy a shit load of steel that they loaned out more times than they have steel.


Like the Tylers and others in the thread, this is where a steel backed bank run happens and people look to cash out of their position.  All the reasons fractional reserve anything is a stupid idea.  Credit is extended to many people for the same object many times over.

Mon, 09/17/2012 - 17:59 | 2805190 Spastica Rex
Spastica Rex's picture

Sudden catastrophic failure.

Possible, but I still don't think it will happen. Preventing that is the real plan, IMO - not the "catastrophic failure" part,  the "sudden" part.

Mon, 09/17/2012 - 18:10 | 2805218 CPL
CPL's picture

Kind of like trying to steer a train.  It's the velocity that kills you.


Feel like we've all been through this tap dance over the last five years repeatedly.  Smoke and mirrors.

Mon, 09/17/2012 - 20:02 | 2805550 Its_the_economy...
Its_the_economy_stupid's picture

Thing is... with a bank run the its only currency that has been re-hypothicated.. Contrrol-P fixes that problem. Not so easy w steel.

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