The economy – see that red light flashing from the East?

I’m seeing a bright flashing red light right now, coming from the Chinese economy.  Developments there seem to be big enough to affect the rest of the world as well.  Consider:

1. Last week, for the first time ever, China allowed a company to default on its bonds.  The government is no longer intervening to shore up the banking and credit system.
2. Furthermore, ‘Fresh loans in China’s shadow banking system evaporated to almost nothing from $160bn in January, suggesting the clampdown on the $8 trillion [shadow banking] sector is biting hard’.
3. China’s exports slumped by 18% last month, the worst figures for many years.

A massive slump in Chinese copper imports has hit the market for that metal very hard indeed – and that’s a known harbinger for other economic sectors.  As Forbes reports:

Copper slumped again Monday on weak Chinese import data, closing down another 1.33%, and hitting lows of sub-$3 early Monday morning. This made the two-day drop in copper a whopping 7% peak to trough. That’s the equivalent of oil dropping to $94.82 and gold falling to $1,255 since Thursday’s close.

That drop represents a significant amount for a major commodity.

Copper is one of the more-predictive commodities (the old saying is that copper has a Master’s Degree in Economics). So it’s disconcerting, then, that copper and other base metals have fallen out of bed the way they have over the past two trading days.

. . .

Apparently the reason copper fell so hard the last few days wasn’t due to the Chinese trade data. Instead, it was because of the default of a Chinese solar company called Shanghai Chaori Solar Energy Science & Technology Co., or “Chaori.” The company missed a $14.7 million interest payment, and in doing so became the first Chinese bond default.

What does that have to do with the drop in copper?

Well, it turns out that copper is used as collateral for many companies that can’t get conventional loans from banks. So, they buy copper in the open market, and then pledge the copper as collateral for cash from lenders. When Chaori defaulted, it reminded everyone that we may see more defaults going forward, and if that occurs, a lot of lenders may be selling their copper to raise cash—and that could cause copper prices to move substantially lower.

. . .

… this sort of “bird’s nest” financial integration, where you see two supposedly uncorrelated assets all of a sudden very correlated, does remind me of 2007 on Wall Street. In fact, the very first signs of stress in the financial markets started to appear early in 2007, and they first appeared in the commodity markets.

There’s more at the link.  Bold underlined text is my emphasis.  GO READ THE WHOLE ARTICLE.  It’s important.

Finally, the BBC recently produced an hour-long TV news program on the Chinese economy titled ‘How China Fooled The World‘.  It’s described as follows (bold underlined text is my emphasis):

Robert Peston travels to China to investigate how this mighty economic giant could actually be in serious trouble. China is now the second largest economy in the world and for the last 30 years China’s economy has been growing at an astonishing rate. While Britain has been in the grip of the worst recession in a generation, China’s economic miracle has wowed the world.

Now, for BBC Two’s award-winning strand This World, Peston reveals what has actually happened inside China since the economic collapse in the west in 2008. It is a story of spending and investment on a scale never seen before in human history – 30 new airports, 26,000 miles of motorways and a new skyscraper every five days have been built in China in the last five years. But, in a situation eerily reminiscent of what has happened in the west, the vast majority of it has been built on credit. This has now left the Chinese economy with huge debts and questions over whether much of the money can ever be paid back.

Here’s the full program.  I know it’s an hour long, but I highly recommend that you make the time to watch it in full.  If this house of cards comes tumbling down, it will – I repeat, IT WILL – bring the US economy down with it.  Consider what Mr. Peston has to say, then contrast that with the government-enforced shutdown of China’s ‘shadow banking’ sector – the sector most exposed to default.

Folks, I don’t know for sure whether all this will lead to some sort of worldwide economic meltdown.  All I can say is, the signs don’t look healthy, and there’s enough unsteadiness in the world economy that even a small disturbance might be the ‘tipping point’.  Consider what the Economic Collapse Blog had to say recently:

None of the problems that caused the last financial crisis have been fixed.  In fact, they have all gotten worse.  The total amount of debt in the world has grown by more than 40 percent since 2007, the too big to fail banks have gotten 37 percent larger, and the colossal derivatives bubble has spiraled so far out of control that the only thing left to do is to watch the spectacular crash landing that is inevitably coming.  Unfortunately, most people do not know the information that I am about to share with you in this article.  Most people just assume that the politicians and the central banks have fixed the issues that caused the last great financial crisis.  But the truth is that we are in far worse shape than we were back then.  When this financial bubble finally bursts, the devastation that we will witness is likely to be absolutely catastrophic.

Again, there’s more at the link, and it’s worth reading.  The author is often considerably more alarmist than I am, but in this article I think he’s pretty soundly based in reality.

Go read all the articles I’ve linked here for yourself, then decide for yourself whether you agree with my interpretation.  Personally, I think that if this continues, we’ll be in the dwang again – this time much deeper than in 2007/08.

Peter