the great unwind

keeping busy

With Monday’s 8% drop in iron ore fines to $104 (below the $120 level cited as necessary for survival) and this morning’s 2% plunge in COMEX copper we are now seeing the unwind phase of yet another Ponzi financing scheme. This is where insolvent entities imported iron ore or copper for the sole purpose of financing to try to meet cash flow needs. The 40% of iron ore inventory left sitting around just for financing represents a tremendous overhang and now that iron ore and copper are quickly unwinding, with the default of Choari Solar a few days ago and now rumours of Baoding Tianwei after its trading suspension (which knocked copper this morning), we are seeing spillovers in other markets. USDJPY suddenly dropped as risk was off while equities turned around in the US.

Shadow bank financing has been skidding to a halt recently and as the Yuan weakens the profitability of this inventory financing wheeze disappears (so that now it apparently is no longer profitable to import these commodities just to borrow money off them as collateral).

So how many dominos are set to fall?

Yet for all the attention that EM political and QE taper related drops have attracted, the even bigger unwind set to come, according to Ashmore (purveyors of EM related investing product–which inconveniently are not in demand at the moment) is in developed markets. The huge debt build up (setting aside China for the moment) has not been in EM countries but developed ones. Ashmore points to the historic disequilibrium currently in markets of massive increases in money printing and debt exhibiting no inflation and negative borrowing costs. I guess that is what you get when your central banks buy up all the bonds to suppress yields and whatnot but the main point is that disequilibrium is, by definition, unstable and eventually unwinds.

In other words, the great unwind currently occurring in places like China, which are now starting to disrupt global markets, will be even bigger when markets free from QE return to their normal relation of higher money printing leading to higher inflation and higher debt leading to higher borrowing costs. Apparently we have a few years to wait for the second great unwind but as with all Ponzi schemes, it must.