Is China decoupling from the $530 trillion derivatives time bomb?

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DrKrbyLuv's picture
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Is China decoupling from the $530 trillion derivatives time bomb?

The international banking cartel was not making enough money via fractional banking and traditional fraud so they had to devise another way to multiply their profits at our expense.  The solution, the mega-multiplying notational trading.  Why limit yourself to a 10:1 fractional creation when you can bet with ratios like one thousand or one million to one. 

Thus the derivatives beast was created.  The monster was crafted to remain unregulated and off the balance sheets.

The numbers are staggering and evidently it is "we the people" who are the on the hook for losses in magnitudes of the global GDP.  Many have suggested that the plug be pulled on all derivatives, bets off so to speak.  Our banking masters want the game to continue and so it looked like we were sitting on a time bomb - extorted to bail-out failing banks in order to keep the derivatives from exploding.  If one of the big banks that are major derivative players were to default, the whole system could collapse like dominoes.

China and the Buzz of a Pending Bank Default

Just this past weekend China announced that State Owned Enterprises (SOEs) will be allowed to default on commodity derivative contracts. Think of that. China has given the green light and authorized the defaulting on commodity derivative contracts.  China owns billions of these products and it has finally come to light they have had enough of having the value of their derivatives manipulated by the manipulation of the price of the underlying asset. They have finally woken up to the fact that these derivatives have been bundled together like junk in a manner that resembles the mortgage backed derivatives that brought down the world markets last year.

This story broke over the weekend but has not gotten much mainstream media attention on this side of the pond. (North America). The only inference to it was the talk or "buzz" on the Wall Street floor that another bank was rumored to be close to defaulting. As Art Cashin of UBS Securities indicated in the video clip I posted earlier, normally when a market sells off on a rumor and the rumor turns out to be false, the market will tend to correct itself. IT DIDN'T.

The Reuters report cited 6 foreign banks that received letters indicating that the Chinese State Owned Enterprises would be given the green light to default on their derivatives. Some of the State Owned Enterprises that stated their potential intentions to default were Air China. China Eastern and Cosco. Mainly in part because they took major derivatives losses over the past year but also, concerns are arising that the derivatives that they were sold by these foreign institutions are garbage, underwater and may never see the light of day.

So why continue to pay for them? So the concern in the financial world is that holders of these losing products may just walk away, not unlike a home owner with a $600,000 mortgage on a home valued at $475,000 deciding to just hand in their keys. However, read on...this has nothing to do with mortgage backed products. This time, the concern may be over Oil.

They (Reuters) cited 6 foreign banks.Where the story gets really intriguing is that among the major derivatives providers according to Reuters but also widely known in the industry, are Goldman Sachs, UBS and JP Morgan.  Here is the looming problem. These products are worth billions.

An important history lesson is needed here. "Potential default" was the concern that sparked and prompted the most recent economic crisis. These intricately weaved products along with highly speculative CDOs and CDSs began to fall apart when the bubble that was in large part significantly contributed to and created by the financial institutions that were packaging this junk started to fall apart.

Imagine the impact for a brief moment if you will, on the impact to the financial landscape if China were to say "we are walking away" from those products. I would imagine that China, being the biggest purchaser of US debt, could surely collapse the US institutions that were at one point deemed too big to fail if they decide to go ahead with this plan.

This is why I don't take tonight's news that China purchased 50 billion dollars of IMF bonds lightly. In fact, I take it very seriously. This is why I take the buzz on the floor over the past two days very seriously as well as I do the incredible spike in Gold today. Most importantly, I do not take lightly the recent 25% correction we have seen in the Chinese Stock Market. Can all these events be interconnected some how? Is the Chinese stock collapse giving us a hint?

Here's a brief overview of what might happen should these companies, and others, default. The banks, namely Goldman Sachs, J.P. Morgan and from other accounts possibly Deutsche Bank will find themselves LONG on oil futures with no customers on the short side of the derivatives.

China warns banks on OTC hedge defaults -report

BEIJING, Aug 29 (Reuters) - Chinese state-owned enterprises (SOEs) may unilaterally terminate derivative contracts with six foreign banks that provide over-the-counter commodity hedging services, a leading financial magazine said.  China's SOE regulator, the State-owned Assets Supervision and Administration Commission (SASAC), had told the financial institutions that SOEs reserved the right to default on contracts, Caijing magazine quoted an unnamed industry source as saying."

On September 1, 2009 Reuters said that the Banks, not the commodities would be at risk if China followed through.  Yes, legal battles would ensue should this happen and we can also expect to have Chinese political figures downplay the story in an effort to avert panic. However, if they can prove that these derivatives or the underlying asset was manipulated in a manner to profit the bank that issued the product then that may even do more damage than the default themselves.

Perhaps the "buzz" on the floor is indeed true. Perhaps we are going to see action that could annihilate one of the biggest Wall Street firms ever.

If there is one thing I have learned of late is that when the Chinese speak, we must listen. Their list of allies is ever growing and they are simply fed up of having to swallow the US garbage that has turned out to be toxic and dangerous to their highly controlled and coveted state owned enterprises.  I leave you with these thoughts that I alluded to above. The Chinese market has corrected 25%. This news broke this past weekend. New York saw a sharp sell-off on Monday.

The selling carried over into Tuesday. Gold, a classic hedge against troubled times has broken out to the upside, China has purchased 50 billion in IMF bonds and has been questioning the US dollar now for upwards of a year.


Note:  A look at what a derivative actually is may be useful here. A Derivative is a financial instrument that is derived from some other underlying asset, index, event, value or condition. Rather than trade or exchange the underlying itself, derivative traders enter into an agreement to exchange cash or assets over time based on the underlying. A simple example is a futures contract: an agreement to exchange the underlying asset at a future date. Commercial and investment banks make up the foundation of the over the counter (OTC) derivatives market. Investors use derivatives to protect against risks, such as sudden changes in price or value of the underlying asset. Others tap derivatives to take on extra risk, in the hope of extra gains.


JAG's picture
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Joined: Oct 26 2008
Posts: 2492
Re: Is China decoupling from the $530 trillion derivatives ...

Why is it that every anonymous blogger (Dan D?.) that is bullish on gold and/or silver, has to cite some rumor about China to make their case?  Larry, this story is beneath your standards. 

DrKrbyLuv's picture
Status: Diamond Member (Offline)
Joined: Aug 10 2008
Posts: 1995
Re: Is China decoupling from the $530 trillion derivatives ...

HI jeff,

Sorry if you found my post to be based on unfounded rumors.  My post starts with my own subject "Is China decoupling from the $530 trillion derivatives time bomb?" which is the point of my post.  The Reuters link substantiates that there is merit to this possibility.  Here is another link from Reuters.

Another article entitled "Is an Oil Derivatives Default Crisis Just Ahead?" suggests "There are facts and speculation that when mixed together sound like a witches brew of trouble in the not too distant future for the markets and economy.  Here are the facts: This past weekend China announced that State Owned Enterprises (SOEs) will be allowed to default on commodity derivative contracts. A Reuters report cited 6 foreign banks [This would be non-Chinese banks] that received letters indicating that the Chinese State Owned Enterprises would be given the green light to default on their derivatives."

The Economist ran a similar story China considers bailing out of costly futures contracts in which it said

GIVEN its vast reserves and seemingly healthy economy, a default by China’s government or one of its tentacles should be one of the lesser concerns for international markets. This perception was jolted on August 28th by reports that the State-owned Assets Supervision and Administration Commission (SASAC) might endorse a move by large state-controlled enterprises under its umbrella to break derivatives contracts that were purchased last year from international banks to protect them from rising commodity prices.

Details, inevitably, are fuzzy. There is no official comment; terrified international bankers are silent. But reports in the local press and some elaboration by participants suggest that efforts by the country’s large shippers, airlines and power companies to cope with high oil prices by taking out futures contracts produced steep losses as the market reversed and prices fell. One theory is that Beijing is trying to squeeze foreign banks out of the derivatives business.

So, I think my post is well substantiated, timely and important.

I'm aware that there is a rumor that a big bank may be about to fail, China and the Buzz of a Pending Bank Default but that is a secondary issue to my concern with the derivatives market and I avoided using that language in the topic of my post.  This rumor has been floating around as can be seen by this MSNBC report "Trader Talk With Art Cashin."

Hope this helps clear things up, thanks for reading my post,


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