George Soros, the legendary investor who made a billion dollars in a single day often spoke about his theory of reflexivity.
In short, a trade or investment or business decision is reflexive when its cause and effect become the same.
House prices in the United States rose because people got subprime loans to buy houses. The rising prices led to more people borrowing to buy houses which made prices rise even further. Until the music stopped.
It is a profoundly circular system which, like all circular systems, has to collapse eventually.
In the case of China’s overcapacity, this is also true. China invested heavily in infrastructure and production capacity over the last decade, driving commodity prices up.
Rising demand and rising prices then prompted mining and commodity companies in China and elsewhere to invest hundreds of billions in new mines and pits to profit from the trend.
This further increased commodity pricesmines consume resources too—, leading to further expansion projects, thus becoming reflexive in Soros’s sense.
Now the circle has reversed an is spinning backwards. China all but stopped investing in new infrastructure and production capacity because the projects don’t generate a return anymore.
But this is just the demand side. With hundreds of billions of extra supply online, global commodity producers are churning out more production than ever, pushing prices down to levels not seen since the beginning of the new millennium. China is flooding the world with aluminum and steel.
(Bloomberg)
 As a result of China’s slowing imports and falling prices, commodity producing countries are either in, or teetering on the brink of recession.
Global mining companies like Anglo American Plc, and Glencore Plc, have shifted gears and are laying off people and selling assets. They are facing billions in losses.
En China, the problem of too much debt spent on non-performing projects is much the same.
 A principios de este año, Australian investment bank Macquarie reported 50 percent of Chinese mining companies cannot even cover the interest expense with their operating profits.
So those companies started to borrow more just to pay their interest expense.
But it wouldn’t be China if the government didn’t get involved in the process of shaking out bad debts somehow. en diciembre. 10, Bloomberg reported China is setting up a state-fund to take on bad debt from the mining sector.
 

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The only thing China had to wait for was the official inclusion into the International Monetary Fund’s (FMI) reserve currency basket.
Now it can devalue its currency as it pleasesand it may not even have a choice.
“A devaluation could be as much as 20 percent against the U.S. dollar because in real effective exchange rate terms the yuan is about 15 percent overvalued at the moment,” says Diana Choyleva, chief economist at Lombard Street Research.
The Chinese currency has gained 15 percent against other major currencies since the middle of last year, according to an analysis by Westpac Strategy Group.
On cue, China set the yuan at 6.414 to the U.S. dollar Wednesday, its weakest level since August 2011 and down 3.4 percent since the mini-devaluation in August.
(Bloomberg)
Choyleva thinks the IMF inclusion may have even prevented a sharper one-off devaluation. “They would not be so keen to be a responsible citizen,” she says and expects further gradual devaluation.
Macquarie analysts also believe Beijing now likely won’t “risk their credibility by devaluing the yuan sharply after that.
But while there is clarity as to how (gradual) and how much (15-20 por ciento) China will devalue, there is still confusion as to why they have to do it.
Market observers usually cite exports as the major reason for a cheaper currency. En teoria, prices for Chinese goods would become cheaper on international markets so volumes would pick up.
En la práctica, this rarely works, as imports become more expensive, as China is a big importer too.
en adición, trade just doesn’t contribute that much to the Chinese economy anymore.
“They were at the peak which was just a few years ago. Their net exports were 8 por ciento del PIB. Now it’s just a couple of percent of GDP,” says Richard Vague, author of “The Next Economic Disaster.
Exports make up even less of GDP growth, barely visible on the chart below. Consumption and investment make up most of Chinese GDP growth.
(Macquarie)
To fire up consumption and not let investment drop of a cliff, China has lowered interest rates 6 times this year.
“You have had six interest rate cuts in the past year. And yet the economy is meant to do fine at 7 percent or so. And that doesn’t tally with the reality on groundthe economy is growing much slower,” dice Fraser Howie, author of “Red Capitalism.
It’s the combination of low growth and easy money which puts pressure on the currency. Because the regime created a debt bubble of epic proportions and investors now realize they won’t get the promised returns, capital is flowing out of the country at a record pace.
Until the imbalances are fixed and China takes its losses, and stops the easy money policies, outflows will continue and the regime will face continued pressure to devalue.

Hasta aquí, the regime has managed the decline by selling foreign exchange reserves. Purely from an economic point of view and disregarding the IMF power politics, it would be better do correct the imbalances with a one off devaluation.
History teaches us that countries spend foreign exchange reserves to defend their currencies and most have to devalue in spite of it. The Russian ruble is a good example from the recent past, the Asia currencies and the British pound are good ones from the 1990s.
So if you can’t have your cake and eat it too, why not just keep it?

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We often hear about wasteful spending and investment in China. We also hear this is not going to end well.

Now the Australian investment bank Macquarie shows us what this looks like in practice. The analysts looked at the bonds issued by 780 companies and $3.47 trillion in debt (a fairly comprehensive sample size) and how these companies are managing interest payments.

The answers to these questions aren’t too pretty.

Like any private person (and very much unlike governments) private corporations have to use their income to pay for interest expense on borrowing.

Finalmente, they will also have to use their income to pay back the debt. If they are able to cover their interest and pay back the debt without making losses, the investment for which the debt was used can be considered successful.

Macquarie now says that more than percent of the companies it analyzed cannot cover their interest expenses with just their income from normal operations (Earnings before interest and taxes or EBIT) or in finance terms are “EBIT uncovered”.

This means their total interest expense for one year is higher than one year’s operating profit. En otras palabras, they have to borrow more money o raise equity to pay the bills. Or default. Most of them are in the mining, materials, and infrastructure business.

“More than half of the cumulative debt in this sector was EBIT-uncovered in 2014, and all sub-sectors have their share in the uncovered part, particularly for base metals, carbón, and steel.”

A breakdown of Chinese bond debt in the commodity sector. Companies above the black line cannot pay their interest with their income. (Macquarie)

A breakdown of Chinese bond debt in the commodity sector. Companies above the black line cannot pay their interest with their income. (Macquarie)

The trend is getting worse: The percentage of companies unable to cover their interest expense went up from 19.9 por ciento en 2013 a 23.6 por ciento en 2014.

Going even further back to 2007, there was only $160 billion in debt and all companies could easily cover their interest expense with operating income.

Because of the critical debt situation, the regime blew up a stock market bubble to facilitate companies’ access to equity—an experiment which backfired as the authorities banned IPOs while the market was crashing.

además, the bond market is usually more competitive than bank loans in China, where lending decisions are often based on political rather than economic factors. The total level of corporate debt including bank loans and bonds, as well as shadow financing is about 125 percent of GDP or $12.5 billones, according to McKinsey.

Who knows how many companies have the income to pay the interest on trillions of banks debt as well.

Fuente: McKinsey

Fuente: McKinsey

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