China set up sovereign funds to manage the national assets it was accumulating through foreign exchange surpluses. Initially, the goal was to set up a nest egg for future generations through foreign investments. Eventually, funds thus set aside could be invested in China itself.
In reality, recapitalisation is an acknowledgement that the heavy losses engendered by bad BOC loans had to be repaid, and that ordinary Chinese would foot the bill for mistakes made by the bank’s top officials as well as the central bank and the Treasury Ministry.
Something similar has happened elsewhere since September 2007, first in the United States (with the failure of AIG and Lehman Brothers and the implementation of the Paulson rescue plan and those that followed), then in the United Kingdom, Ireland, Switzerland, France, Germany, Belgium Netherlands, etc. Eventually, it became so much the rage that it was applied in other places, under other climes, beginning in Dubai.
In any event, recapitalising banks like the BOC is what Chinese leaders have always done (AsiaNews wrote about it six years ago); first, by accumulating convertible currency reserves thanks to a favourable exchange rate that undervalued the yuan, and then by re-financing the banking system drained on a regular basis by politically-motivated loans in order to allow the Chinese Communist Party to maintain its stranglehold on the country. This suggests that the situation is structural, systemic, and that nothing has changed. As information, the BOC recapitalisation is just a technical event, financial news for pundits.
Bank debt and public debt
There is however something new in all this. A month ago, the BOC raised 40 billion yuan by selling bonds convertible into traded shares, thus diluting its capital by less than 1 to 3. Similarly, other Chinese banks have announced recapitalisation plans worth billions of yuan, banks like the China Construction Bank and the Industrial and Commercial Bank of China. The Agricultural Bank of China has also announced a recapitalisation of 30 billion yuan.
Just like the wider public, we know how propping up banks and firms deemed too big to fail (in the “national interest” they used to say in Fascist Italy) tends to end.
When many banks become insolvent, rescue packages by governments simply shift the burden from the banks to the sovereign, or public, debt. Although we do not know how fast this is happening, the Greek contagion appears to be spreading to China. Yet, given the steep and speedy hike in the markets of Credit Default Swaps in Chinese public debt (which transfers insolvency risks to third parties), the shock wave in this case could travel faster than before.
It would almost appear as if the United States and China are moving in sync on the rim of a structural cleavage in the system. Following the failure of Obama’s and Hu Jintao’s stimulus packages, both countries seem to be moving towards public insolvency, hopefully one with soft landing, spread out over many years.
The alternative would be a traumatic event or better a series of consequential rare events whose probability is statistically non-computable, akin to Nassim Nicholas Taleb’s so-called ‘Black Swan Events’, that is events that cannot be integrated, predicted or forecast by the mathematical algorithms used in the statistical and economic theories that underlie “derivatives”.
In addition to a possible war in the Persian Gulf, bankruptcy by BP could be another possible ‘Black Swan’ because of the cost in damages and compensation the oil giant might have to pay for the Gulf of Mexico environmental disaster. If it did happen, it would be a repeat of the Lehman Brothers collapse (preceded by the rescue of Bear Stearns), but on a far greater scale.
Like other oil companies, BP plays a huge role in the derivative market, more than any big bank. When issuing derivatives, it can offer as counter security, real assets, gas and oil in its wells across the world.
The ‘derivative’ market is highly interconnected. If BP should go under or lose its AAA credit rating, which is quite likely, the mountain of atypical, non-traded bonds in the US$ 615 trillion market would be caught up in a windstorm and collapse. It would thus be the trigger of an unprecedented financial upheaval, comparable to what led to the extinction of the dinosaurs.