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hardnox
Advisor

elephant in the room

http://www.macrobusiness.com.au/2014/02/chinas-iron-ore-build-a-dodgy-dash-for-cash/

 

Or really more of an exotic creature, a unicorn or platypus or something. 

 

The matter of the Chinese using stuff like copper and nickel and other commodities as collateral in the shadow banking system that goes through multiple rehypothecations is fairly well established.

 

Speculation on the extent of the game extends to cotton where they also hold huge warehouse inventories. But in all fairness I've never seen a bit of suggestion that it extends to grains.

 

But why wouldn't it?  True that copper has a higher value density than grains- true even for cotton. Not so for iron ore, which the above article identifies.

 

I guess the only real difference is that grains are modestly perishable, the other commodities mentioned are less so, to a greater or lesser extent, and probably require less specialized storage.

 

Dunno. But in general you can say that the demand for those commodities that are held as collateral would increase when there is a modest liquidity crisis in the shadow sector as-there currently is.

 

Also, the potential for a self reinforcing spiral, in either direction, seems present. If you're sitting on scads of a commodity that's been loaned out X4, you really don't want the price going down so you'd be inclined to keep the game up. The potential for the spiral in the opposite direction seems obvious.

 

The downside is that some quantity of those things hasn't really gone away it has just been tied up in a financial hoarding scheme. As to how it might end and what the ramifications would be, I haven't a clue but I can guess.

 

I think that kepping an eye on it is important on two different orders of magnitude. One is the fragility of the Chinese shadow banking system in general where a hard crunch would have severe knock on effects for the global markets. That's the lesser of the two. The greater is the impact on the price of the commodities themselves should things get out of control.

 

Thinking this through I think that the comforting fact is that, counterintuitive as it is, every effort will be made to keep that from happening. That's becasue of just how darn important it is- a broad commodity collapse coupled with a sharp liquidity contraction would almost surely kick off a global deflationary spiral.

 

So I guess we go forth and have our children say their prayers for the Gods Above the Clouds on Mt. Olympus who are keeping all those balls in the air. For our good, of course.

 

 

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7 Replies
hardnox
Advisor

Re: elephant in the room

Help my tiny brain out, it is short on RAM.

 

If loss of liquidity creates a margin call on an asset (commodity in storage, in this case), wouldn't the net effect be that in the short term it increases demand for said commodity?

 

i.e., isn't it basically a synthetic short position?

 

 

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kraft-t
Senior Advisor

Re: elephant in the room

The question is why do we think that currency backed up with gold is any more secure than currency back up with other valuable commodities?

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hardnox
Advisor

Re: elephant in the room

Lack of perishability is one of the unique qualities of gold. Estimates are that something like 80-90% of the gold that has been mined since antiquity is still around.

 

Along with rarity and high value/density. Even though the supply goes through periodic cycles of hoarding and dishoarding, quantity stays relatively constant. Mine output didn't explode even when gold was hitting $1900/oz cuz that stuff is hard and costly to get at.

 

Iron ore is finite at some distant point but the Aussies and Brazilians can dig a whole lot more up- and have the ready capacity to do so, should the market give the price signals. Which is exactly what a ponzi hoarding scheme would encourage.

 

 

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hardnox
Advisor

Re: elephant in the room

But put aside the open question about how strong the hands are if the inventories are tied up in dodgy finance deals.

 

In theory, a country that is resource poor, relative to the population and size of the economy, and holding a huge balance of trade surplus can hoard an enormous amount of stuff if it chooses to as a matter of policy.

 

And I suppose that policy could even be implemented via encouraging private financing deals rather than as a matter of direct government purchases.

 

And it probably becomes somewhat self reinforcing insofar as the value of those inventories would drop substantially should the stockpiling stop.

 

An interesting and thought provoking line of inquiry.

 

 

 

 

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hardnox
Advisor

Ambrose is on the case

Worth reading the whole thing

 

http://www.telegraph.co.uk/finance/comment/10634339/World-asleep-as-China-tightens-deflationary-vice...

 

"Officials from the International Monetary Fund say privately that total credit in China has grown by almost 100pc of GDP to 230pc, once you include exotic instruments and off-shore dollar lending. The comparable jump in Japan over the five years before the Nikkei bubble burst was less than 50pc of GDP"

 

 

The one thing that I'd say is that although it is rather counterintuitive, the initial liquidity squeeze probably creates additional demand for commodities as a desperate bridge to financing.

 

After that I guess it is a question of what the gods decide to do.

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425Cat
Advisor

Re: elephant in the room

China plans to control the eastern hemisphere if not the western also thats all you need to know about china
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Palouser
Senior Advisor

Re: elephant in the room

The government in China is in firm control of commodity values in China. There is no way to safely speculate on grain in China. It can't be exported who license and grain is a national security issue. If it appreciates the gov will do a surprise knockdown. Hoard it anyway and the gov will identify the warehouse and force release. Too low a value and too hard to store and move because of the low margins, and no one would be allowed to control a sufficient amount to affect the price one way or another. The government controls vast quantities off limits to everyone in enough quantity to start a scheme and all are aware of it.
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