Massive debt for equity swap inside China

[ThePythonicCow]

Zerohedge is reporting that China has mandated that several major bankrupt companies within China be taken over by the Chinese banks they owe money to: China Has Quietly Bailed Out Over $220 Billion In Bad Debt In The Past 2 Months.

The banks will become the primary stock holders of the companies. The existing debt and existing stock in the companies will be canceled.

Zerohedge is not impressed ... finding this to be just a shell game making way for more debt.

I have a different view.

China's debt has risen dramatically over the last few years, but unlike many other nations, their debt is internal. Their companies owe money to their banks. Unlike the US and many other nations that owe massive amounts, as nations, the Chinese national government has massive reserves, such as of US Treasuries.

There are essentially three ways to handle an excess of debt:

• Default - just don't pay it.
• Inflation - cheapen the money that is owed in repayments.
• Debt for equity swap - replace the debt with equity, which might yield future profits if the debtor firm/nation does well later on.

China has a fundamental advantage in such operations, being a centrally controlled economy. They can mandate reform, top down.

They have just used this advantage, and begun mandating that the excess debt of some of their companies be replaced with equity - a call on future profits, if any.

In my view, this is the best of the three ways to handle excess debt, and it is a demonstration of China's advantage in being able to handle such affairs. What was a serious weakness for China, the excess burden of debt payments in their companies during this deepening economic depression, is being lifted.

If Donald Trump were to ask me how to handle the excess of US debt, when and if he takes office next January 2017, I would recommend that the US do its own debt for equity swap. Dismantle both the Federal Reserve and the Internal Revenue Service (which administers the US national income tax), and institute instead a national sales tax, with a mandated portion of which would be paid to those who had held our US federal debt, instead of paying that debt and interest back. (There is zero chance that Trump will ask me, and almost zero chance the US will do this, of course.)

This is a major move, and a strong move for China. The world's economic, financial, and monetary affairs are progressing relentlessly toward a reset that will end the US Petro-Dollar reserve system, remove the US from the pinnacle of world power, involve a substantial economic collapse and depression, and lead to the next world monetary system.

This new world monetary system will evolve out of International Monetary Fund (IMF) Special Drawing Rights (SDR's), as implied by Zhou Xiaochuan, governor of the People's Bank of China, in this MarketWatch article a month ago: China aims to make IMF’s special drawing right a real currency.

However I continue to anticipate, as I posted two months ago in How the global monetary conspiracy is unfolding, that this new monetary system will unfold towards having a foundation, in the core reserves of the world's nations, in gold and silver and other such tangible assets, not in the bonds and other such debt paper issued by banks.

Debt will surely remain, as corporations, nations and individuals will continue to borrow. But the debt will be denominated in terms of various currencies, the value of which will rise and fall depending on the precious metal reserves and the trading balance of the nation issuing such a currency.

[Cognitive Dissident]

Hi Paul. I'm working in Beijing right now and follow these things fairly closely, so I can give you my perspective.

The debt for equity swap was smart, but it doesn't address the fundamental problem - many big companies are losing money, and will continue to do so.

The reasons why are many and complex, but the problem is basically structural - the whole economy has massive overcapacity (steel being the most obvious one, but there are others) and capital has been poured (almost literally) into infrastructure and new buildings which are not really required.

It's the same problem Japan had in the 1990's, but on a much larger scale.

http://www.zerohedge.com/news/2016-0...y-deteriorates

This story illustrates the problems. Because the system is so controlled, they will be able to keep a lid on it, for a while. After that, who knows.

My personal opinion is that this is one of the reasons for the political crackdown. They need to make sure they have everything under control, as far as possible, before things get hairy, because it won't be possible afterwards.

[ThePythonicCow]

Posted by Cognitive Dissident (here)
Hi Paul. I'm working in Beijing right now and follow these things fairly closely, so I can give you my perspective.

The debt for equity swap was smart, but it doesn't address the fundamental problem - many big companies are losing money, and will continue to do so.

The reasons why are many and complex, but the problem is basically structural - the whole economy has massive overcapacity (steel being the most obvious one, but there are others) and capital has been poured (almost literally) into infrastructure and new buildings which are not really required.

Well said - and thanks for the "inside" (or at least, on site) perspective.

Zerohedge has a second article on this topic, with further analysis of how this debt-for-equity swap can be expected to interact with China's economic, financial, and monetary situation.

Yes - it seems you and Zerohedge agree - China still has some big and increasing problems. In addition to the massive overcapacity that you describe, this debt-for-equity swap will also place an enormous burden on their banks, which are being forced to write off the debt they had been carrying on their books as assets, expecting interest and principle payments. This will likely require a massive injection, that could reach over a trillion US dollars worth, from the Chinese government to keep their major banks from going bankrupt.

The second Zerohedge article is here: Kyle Bass Was Right: SocGen Does The Math On China's Staggering NPL Problem, Issues Dire Warning. The abbreviation "NPL" stands for "Non-Performing Loan", and within the article, I suspect that the abbreviation "SOE" stands for "State Owned Enterprise".

This second Zerohedge article is presenting an analysis by the French SocGen's Wei Yao. They begin their quotes of Yao with this:

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China is still leveraging up rapidly, with its nonfinancial debt up to 250% of GDP [ZH: realistically 350%]. The corporate sector and capital market liberalisation that the authorities are pushing for has begun to destabilise the debt dynamics. The beginning of debt restructuring for SOEs, the biggest borrowers and underperformers, brings closer the prospect of bank restructuring – a scenario we think that has a probability of more than 50% over the medium term.

As SOE restructuring progresses, it will also become more apparent that Chinese banks need to be rescued.

We estimate that the total losses in the banking sector could reach CNY8 trillion, equivalent to more than 60% of commercial banks’ capital, 50% of fiscal revenues and 12% of GDP. The actual tally may still be years away, but could be more sizeable if problems continue to grow.

China may still be able to dodge an economic crisis while restructuring its corporate and banking system, but the margin for error will be uncomfortably slim.

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Zerohedge comments further on Yao's analysis:

To repeat SocGen's shocking conclusion, SocGen estimates that the total losses of banks could reach CNY8tn (or over $1.2 trillion), equivalent to more than 60% of their capital. It is also equivalent to 50% of fiscal revenues and 12% of China's total GDP!