By John Richardson
WHEN something seems to be so obviously too good to be true, based on lots of contrary evidence, then it usually is.
And so here’s the thing:
- Nobody should take any serious notice of the 15.3% year-on-year rise in September’s exports because all the evidence points to something being very wrong with this piece of data.
- This includes the mountain of very valuable evidence, from our ICIS pricing service, that China’s peak manufacturing season, which took place from July until around the end of September, was a big disappointment.
- And then you have the latest World Trade Organisation (WTO) report on global trade, which was released late last month. The WTO revised down its forecast for global trade growth in 2014 to 3.1% , from the 4.7% that it had predicted in the spring. And even this revised-down prediction looks a stretch, given that global trade only expanded by 1.8% in the first six months of this year.
- We also now that the Eurozone is mired in deep economic problems, and that Europe accounts for one-third of global merchandise trade. So how can China have really seen a 15.3% rise in exports when Europe is so important to global trade?
So, what should we make of the 15.3% headline increase in exports?
When the number was announced on Monday, in the context of all the above, this should have immediately raised the suspicion that “fake invoicing” was a major cause.
We know that the same type of fraud was behind unexpectedly strong exports in July and August.
Sure enough, therefore, it has emerged that:
- Exports to Hong Kong, the favourite route for these fake invoices, rose by a very suspicious 34% in September.
- Excluding the jump in exports to Hong Kong, growth in overall exports was, in fact, 12% – pretty much unchanged on a year-on-year basis.
- Hong Kong exports outstripped those to the US in September. Hong Kong has a population of seven million. The US has a population of 320 million.
- We should know for certain what has really happened on 27 October. This is when Hong Kong publishes its trade figures for September. Large discrepancies between mainland China and Hong Kong trade have occurred during previous periods of “fake invoicing”, such as April last year.
“As in the past over-invoicing is a key channel for hot money to enter China,” said Shen Jianguang, chief Asia economist at Miizuho Securities in Hong Kong [ we prefer the term is “fake invoicing”, as “over invoicing suggests a kind of clerical error, whereas, what we are really taking about here is entirely fictitious exports – in other words, outright fraud].
Here is a reminder of how and why this scam works:
- An exporter sends a businessman, who is often based in Hong Kong, a fake invoice for goods (this businessman might well work for an offshore subsidiary company owned by the exporter in China).
- The businessman pays the invoice by depositing dollars in the local manufacturer’s offshore bank account.
- The manufacturer then uses the export paperwork to get permission from his bank to convert the dollars into Yuan. The factory owner may also get a fee from the investor, and can collect a VAT rebate on top.
- Money raised by the fake invoice is then invested in the shadow banking system at annualised interest rates of 12%.
- The idea, of course, is to make so much money from speculation in shadow banking that this pays a healthy return to both the local manufacturer and the offshore businessman.
- Plus, as happened late last year and into early 2014, the Yuan has been appreciating of late. And so there is also an opportunity to make a foreign currency gain.
We strongly suspect that, as desperate property developers scramble for financing during China’s Great Rebalancing, this export scam has re-emerged.
The scammers realise that the property developers are desperate to borrow money, and the only financing route available for these developers is the shadow-banking system. Increased demand has led to increased supply.
And we also think that, as China plays its whack-a-mole game, the next mole to be whacked is likely to be this export scam.
Another mole already being firmly whacked into place is the opposite type of fraud – import scams that took place earlier this year.
Here, polyethylene, monoethylene glycol and copper and aluminium were imported, just so the importers could use the foreign letters of credit to again speculate in shadow banking.
The focus has obviously switched to exports because the import route is being blocked.
What does this tell us?
It is this:
- Before the Great Rebalancing began, you could “buy on the rumour” of the sustainability of China’s growth model and sit on your position for years, as the facts were hidden.
- The facts were hidden during 2008-2013 by a huge rise in credit. As a result, you didn’t have to worry too much if there was no substance behind rumours such as “China will become a nation of BMW drivers”. If you were an exporter, you could sell just about all of your excess chemicals and polymers to China.
- But now you need to “buy on the rumour and sell on the fact” very quickly, if it is worth buying at all.
- For example, on the day that the September export surge was announced, the Shanghai Stock Exchange composite index actually fell by 0.36% to 2,366 points.
- Taking the headline export growth number at value would therefore, obviously, be of no use whatsoever to anyone producing or trading chemicals and polymers.
And this piece of distorted export data also tells us this:
- As the New Normal develops, it is absolutely essential to challenge headline data, to dig much deeper.
- This involves asking harder questions of yourselves, your colleagues and your contacts.
- This will be an uncomfortable and difficult process.
- But it quite simply has to be done as we have no other choice.