Fears Over China's Currency

Interesting piece on the move toward a larger official trading band for the Chinese yuan, at the New York Times, "In China, Shaking Up Currency’s Strength."

Beijing heavily controls the value of the yuan (when it appreciates against the dollar, Chinese goods become more expensive, potentially hurting the country's export-led economy). But what fascinated me about this piece was the effects on global traders from the default of a major bond investor to the tune of $163 million:

Over the years, China’s investors and trade partners have come to rely on what amounts to a “Beijing put,” an option that provides assurance that a minimum level of growth will be attained. When the country looked set to fall short, the government would intervene to prime the pumps — freeing up credit, introducing subsidies and otherwise ensuring that China avoided any real economic pain and remained on track as the world’s fastest-growing major economy.

Yet in the face of apparently slowing growth, this implicit guarantee is showing signs of fraying. Markets around the world are growing worried, from Australian iron ore miners to the luxury fashion houses of Europe to American scrap exporters.

Take copper, where global prices have fallen sharply in recent weeks. This is partly the result of concerns that growth is slowing in China, which accounts for more than 40 percent of global consumption of the metal. But the falling prices represent another, bigger fear — one that focuses on the role copper plays in China’s huge shadow finance sector and the realization that Beijing will not always be there with a bailout.

Many Chinese companies and investors buy copper they have no intention of using. Instead, companies that otherwise have difficulty securing traditional loans will purchase copper from overseas suppliers by using letters of credit issued by banks, which only require a deposit of around 15 percent of the value of the goods being purchased, according to analysts.

The Chinese importer then parks the shipment of copper in a duty-free warehouse and uses it as collateral to secure a bank loan at favorable rates, the proceeds from which are used to make higher-yielding investments. When the letter of credit comes due, usually in three to six months, the importer cashes out of the financial investment or sells the copper.

This month, a small producer of solar panels based in Shanghai failed to pay the interest on a bond worth 1 billion renminbi, or $163 million. It was the first default in China’s onshore corporate bond market in recent history, and it sent shock waves through global copper markets.

Investors are worried that Chinese buyers who imported copper purely for financing purposes could be forced to sell, and prices of the metal have plummeted on fears that hundreds of thousands of tons of copper could begin to flood global markets as a result. As of Friday, benchmark three-month copper contracts closed at $6,469 per ton on the London Metal Exchange, down more than 8 percent from March 6, the day before the panel maker, the Shanghai Chaori Solar Energy Science and Technology Company, defaulted. Chaori’s default “was probably the trigger” for the slide in global copper prices, said Helen Lau, a senior metals and mining analyst at UOB Kay Hian in Hong Kong.

“Before, people still had wishful thinking that the government would bail out whatever, but now?” Ms. Lau said. “One default can lead to another. People are really scared.”