Month: July 2015

On Chinese Accounting

Excellent post on the quality of Chinese numbers, corporate as well as gdp. Nothing new, but the author gives a good overview on the implications. Interestingly – and somewhat news to me – the Chinese are well aware of this, contrary to most western observers (and corporate CEOs) who still think China is going to take over the world. From the post,

Inside China, it is taken for granted that the statistics are worthless and has been for many years. I was first alerted to questionable data not by academic research, a troublesome foreigner, or journalist but by my students. They were in disbelief that a professor would actually believe official Chinese data as everyone already knows the data is manipulated.

Regardless of whether you believe this is going to end badly or not, I think we agree that China is a fascinating place.

People in (western) Europe, or the US have the unfortunate habit of trusting their government. This is why they tend to believe official statistics even though locals do not – a costly error in many a EM crisis. In the past this trust might have been justified, but now…


More on declining Chinese FX reserves…

… from Russel Napier here (via Zerohedge). I fully agree with him that defending the peg and the corresponding reserve-drain is a game changer. Whereas the whole world is focused on whether the Fed will hike or not, global liquidity conditions, as exemplified by declining FX reserves in EMs, have been tightening for a while. Of course, a fed tightening would merely reinforce this trend, since the expanding US monatary base has enabled the distortion to build. Napier summarizes beautifully,

(…)One day we will tell those much younger than ourselves that once upon a time there was a large economy that ran a surplus on both its current account and on its capital account for more than twenty consecutive years. We will tell them, when they’re sitting comfortably, that because it went on for twenty years everyone assumed it would go on forever, despite the fact that such a thing had never ever been seen before. Then one day it ended. And the world thought that this would pass or, if it didn’t pass, they thought that it was not of great import (…)

Think about how many unsustainable capital structures have been built around this epic credit expansion. By this I do not only mean the obvious candidates like commodity exporters. It can be argued that the global shifts in, say, manufacturing capacity have been greatly exaggerated by 20 years of easy money in China. Given that most businesses in China only exist due to low cost of capital (think solar panels), it can be argued that many a manufacturer in DM has been pushed out not because of a lack of competitiveness, but because of easy money in China.

Disclosure: short AUD and CNY

Meanwhile in China…

…capital outflows have reached a new record (I have written about China capital flight before). This article gives a good overview of current developments,

(…) Yet the underlying picture in China is going from bad to worse. Robin Brooks at Goldman Sachs estimates that capital outflows topped $224bn in the second quarter, a level “beyond anything seen historically”.

The Chinese central bank (PBOC) is being forced to run down the country’s foreign reserves to defend the yuan. This intervention is becoming chronic. The volume is rising. Mr Brooks calculates that the authorities sold $48bn of bonds between March and June.

Charles Dumas at Lombard Street Research says capital outflows – when will we start calling it capital flight? – have reached $800bn over the past year. These are frighteningly large sums of money (…)

This is not surprising, after all the main reason for the outflows, an overvalued real exchange rate, is still in place. Further, Chinese creditors are systematically short USD (to the tune of 1 trillion) mainly backed with cash flow negative projects. I expect the outflows to continue, as the repercussions of the stock market crash further diminish the demand for CNY.

If China does not want to loosen its peg, it has no choice but to sell US-Treasuries. I do not know whether the impact on the Treasury market is big enough, but given that the Fed some ten years ago was concerned about a global “savings glut” having impact on long-term rates, it could equally be worried about the “reverse savings glut”. Whether the Fed hikes or not, USD liquidity is tightening…

It’s getting nasty in commodity space

Very good piece in the FT on the accounting irregularities at Noble group, Asia’s largest commodity trader, which has come under scrutiny of short sellers,

The critics allege the Hong Kong-based company — which acts as a middleman for buyers and sellers of oil, coal, iron ore and metals — is providing a misleading picture of its financial performance. They claim Singapore-listed Noble has pushed the limits of international accounting standards, so that it can record profits on long-term deals to source and supply commodities well before the company receives any cash payments.

Short sellers argue this is material: the discrepancy between cash flow and accounting profit has accumulated to more than two billion USD over the past few years. Moreover, the value of these long-term contracts (USD 4.6bn) accounts for 90 percent of Nobles book value, way larger than at other commodity traders where this figure is in the low single digits.

But there is more. Noble also has stakes in various mines whose valuation is equally questionable. For instance, Noble’s stake in Australian Yancoal has is valued at USD 12mln on the market, whereas it sits at USD 322mln on Noble’s books, according to its 2014 annual report.

The first question I have: Where is the auditor?

I have seen many discrepancies between carrying values and book values, but this one must be the most egregious one. Especially since no one can argue with a positive outlook, now that the Chinese mandarins cannot even control their stock market anymore, let alone the economy.

The secular commodity bull market has provided many a company (and country) with a one-time windfall. As is typical, they have not attributed this to sheer luck (and record Chinese money growth), but to their own genius. A bull market like that historically comes with dodgy accounting (think of all the bonus possibilities) and it is unlikely that this is limited to the Noble group only, although it looks especially egregious (as far as I can tell from the article, adjusting for the profits and revaluing the participations mentioned, there is not much of equity left).

People usually argue that commodity traders are no banks and hence contagion is limited. I am not sure: think of all the trade financing that has accompanied the rise in global trade over the past 30 years. It sits on the books of the banks as a low margin/low risk assets. Surely a default of a huge commodity trader has the potential to rock this boat…

(Disclosure: short AUD and CNY)

A new perspective on unicorns

As a follow-up to my tech post, I recommend this excellent blog entry by Scott Fearon. He points out that most of what is sold as high-tech to investors nowadays seems oddly low-tech,

But what seems different to me about the current tech boom is just how un-technological most of the players are. Uber lets you hail someone else’s car, AirBnB lets you sleep in someone else’s bed, and Snapchat lets teenagers erase naughty messages before their parents see them. It’s hard to see any significant technological moats around those ideas.


Seattle-based Zillow (Z) might be the perfect example of how “untech” today’s tech sector is. I have visited its headquarters several times. The place is straight out of movies like Boiler Room and Glengarry Glen Ross. Most of Zillow’s employees are not coders or developers. They’re commissioned salespeople. They sit in cubicles adorned with Seahawks posters and cold call real estate agents all day, aggressively promoting “leads” in assigned zip codes. All those flesh-and-blood employees and their intensive sales efforts have generated impressive revenue growth for Zillow. But they also bring relatively large operating expenses.

Investors in those ventures would probably reply it’s the network effect that constitutes the moat once you have enough people on. To me this line of reasoning seems faulty: how valuable is the network effect if you offer an unnecessary service like snapchat, or twitter? How, exactly, do they improve the world? They seem more like fads than anything else. Similar to Crocs a few years back. Will the network still be valuable once your product/service is not fashionable anymore?

A reader from Greece writes in

Long-time reader George from Greece with an interesting analysis on today’s referendum. The most important part,

Neither Greece’s ailment, nor its cure, is its currency, be it the euro or the drachma, or its pensions—whether too low or too high. Greece’s cancer is the purely domestic cleptocracy which has been sucking the country dry for at least thirty-five years (that’s as far back as I can remember, older people may argue this may have been going on for much longer).

You think I’m exaggerating? Let’s look at a couple of interesting statistics, then. According to the UN comtrade database, supplies of bunker fuel to ships in Greece went from $25m in 2008 to $1.72bn in 2014. Exports of fuel to Turkey went from $204m in 2007 to $3.2bn in 2014. Exports of fuel to FYR of Macedonia in the same timeframe went from $72m to $614m (for comparison purposes, Greece’s GDP in 2014 was $238bn). Either Greek refineries got very efficient during the crisis, or other refineries in the region got very inefficient. Or it could be that the cleptocrats, hit by the crisis in their other half-way legit businesses, had to supplement their income with other, far more lucrative ventures.

Well, according to the New York TimesOrganized crime […]dominates the black market for oil in Greece; perhaps three billion euros (about $3.8 billion) a year of contraband fuel courses through the country. Shipping is Greece’s premier industry, and the price of shipping fuel is set by law at one-third the price of fuel for cars and homes. So traffickers turn shipping fuel into more expensive home and automobile fuel. It is estimated that 20 percent of the gasoline sold in Greece is from the black market. The trafficking not only results in higher prices but also deprives the government of desperately needed revenue”.

According to the FTGeorge Papandreou, the former socialist premier who resigned in 2011, also claimed he was brought down by oligarchs after a finance ministry campaign to tackle widespread fuel smuggling revealed a Balkanwide scam that cost Greece €3bn a year in lost taxes”.

Its’ not as if these smugglers are thousands. They’re a handful of people, whom practically every Greek knows by name. Unlike Escobar, they are not in hiding. They’re feted by the press as “successful businessmen” and are being sat next to prime ministers.

There are similar tales to be told in natural gas, energy and practically every sector that has to do with the state.

If that’s not fixed, irrespective of whether the currency of Greece is the euro, the drachma or the rupiah, there can be no end to Greece’s plight. Is Tsipras likely to fix that? I’ll give you a hint: most Greek oligarchs voiced their support for Tsipras ahead of the general election in January. Before him, they of course supported his predecessor.

What I think, is that Greeks should be united in their fight for the rule of law and against the cleptocracy, and not divided over a referendum on an absurd question. That division, however, serves the cleptocrats well—they can go about their usual ways unnoticed. Whoever said “divide and rule” knew what they were talking about.

Many people in “the West” simply cannot imagine the amount of corruption in the average Balkan country. They fail to understand that this is only possible BECAUSE the state plays such an important role in everyday life, i.e. “making the state stronger” in Greece by improving “tax collection” only worsens the situation. As my Neapolitan friends always tell me when I question them about the mafia: “ma, Il mafioso piu grande e lo stato”….

Of course, the fight for “social justice” and the increasing socialization, i.e. politicazion, of societal questions we are witnessing here will lead to similar results. As I always tell my Austrian and German friends when asked about my opinion on Greece: “(If nothing changes here) Greece is before us, not behind us…”

David Stockman on Greece

David Stockman on the troika’s negotiating position,

(…) Secondly, the troika cannot give honest debt relief anyway. That’s because officialdom is now petrified of their own taxpayers—-whom they have betrayed and baldly lied to from the very beginning. Thus, the IMF has now loaned Greece $35 billion in gross violation of its own credit standards and long-standing rules. Were it ever to take the huge write-offs that are objectively warranted by the actual facts of Greece’s economic and fiscal situation, it would be eaten alive in the legislative chambers of its member governments.

Indeed, in the case of the $6 billion share of the loss attributable to the US quota, the Republican congress would have a field day investigating the incompetence and misdirection underlying the IMF’s role in the Greek bailout. The IMF would never again achieve a congressional majority for a subscription funding increase—effectively putting it out of business.

And that’s nothing compared to the political explosion that would be unleashed in the national parliaments of the Eurozone itself—– were proper debt relief to be granted. As shown below, the Germans are on the hook for $56 billion of the direct fiscal debt, but that’s not the whole of it by any means. Through the backdoor of the ECB, German taxpayers have also loaned Greece another $36 billion in the guise of liquefying the collateral of the Greek banking system.

“Liquefying” my eye!

The Greek banking system is hopelessly insolvent; the so-called “Eurosystem” obligations shown below are nothing more than fiscal transfers. Accordingly, what the clueless Angela Merkel actually accomplished during five years of weekend Gong Shows was to bury her taxpayers under $92 billion of liabilities—–nearly all of which are off-budget and unacknowledged.

Her desperate and mindless temporizing in order to remain in power thus constitutes a monumental political lie and betrayal. Were this to be exposed by a major write-down of the Greek debt,it would lead to an instant fall of her government.

The same is true for the rest of the Eurozone—only the facts are even more egregious.

France’s share of the fiscal debt is $42 billion and its total obligation including the ECB exposure is $70 billion. But France has not had a balanced budget in 40 years; is suffering from record unemployment and a decaying economy that has been suffocated by socialist taxes and regulatory dirigisme; and will soon join the triple digit club on its public debt. Accordingly, its government is petrified by even mention of Greek debt relief.

Then you have Italy buried under a 130% debt-to-GDP ratio and an economy that is 10% smaller in real terms than it was 7 years ago. So it is not surprising that its paralyzed, caretaker government does not wish to contemplate even the prospect of a write-down on the $37 billion of fiscal debt owed by Greece or the $60 billion of total exposure.

Then there is the crook and fiscal phony running Spain. No wonder Mr.Rajoy has practically threatened to take out a contract on Alexis Tsipras’ life. Spain’s economy is still grinding away 15% below its boom time peak and its government is faking its fiscal accounts to a fare-the-well. Still, its public debt continues to rise toward 100% of GDP (…)

Could not agree more. It’s not only the Greeks who find themselves between a rock and a hard place…

I am curious how they will try to come out of this. They will probably have to suspend the GDP/ central bank accounting rules!