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Circulating in China’s Financial System: More Than $200B in I.O.U.s (nytimes.com)
101 points by nafizh 76 days ago | hide | past | web | favorite | 85 comments

If companies have no cash to immediately pay suppliers, then those suppliers must wait for payment. In the US, there are 'invoice factoring' companies who will buy these unpaid invoices. They provide the cash up front, in return for some reasonable-but-not-perfect security (the unpaid invoices) and a discount.

From the article and the first few Google search results, it seems like 'Commercial Acceptance Bills' solve the same problem. They create liquidity for suppliers without reducing their customers' immediate liquidity.

And their liquidity seems to come from:

- banks widely supporting their purchase

- being transferrable

- having a future date (I'm not sure, but this part sounds like it might be like writing a post-dated cheque)

Given we normally like financial innovations that increase liquidity and keep markets moving, why should we be concerned about this market, whose current stock is less than 2% of China's annual GDP?

It doesn't seem like the mechanism is what people are worrying about. It depends on whether the illiquidity is just a temporary thing or if it represents debt that will never be paid. If 2% of the GDP is fake/unresolvable debt, that's a huge, huge problem.

If it's a constant stock, sure there could be a sudden loss in confidence. But if the stock is constantly turning over due to existing certificates reaching term, others changing hands at increasing discounts, and new ones being issued, then perhaps no party risks a sudden, large loss.

Well, that's the question, isn't it. If it's truly steady state, then it works. But in practice, firms that miss one payment tend to miss the next too. This kind of debt arbitrage (and other related tricks like payday loans and collections agencies) tends to only work when it's a one-off kind of thing, or if the entities are so small that the overall risk to the system is low.

The contention here is that a whole economy is filled with this, to the tune of 2% of GDP! I mean, I don't know whether or not this is solvent but if it were my economy I'd be awfully worried.

Basically because:

1. Things are very different in China. If you can get away with not paying, it's not really wrong in the same way as in America. They have a different business culture based more around mutually assured destruction.

2. China has a massively leveraged internal economy, propped up by massive stimulus with the RMB. Only because of the two-currency BS they pull can they continue making this work. But because external nations don't actually use RMB, they could end up having a worse recession because of it. Or maybe better, because of the two currencies. Honestly, it's hard to know.

3. It's much harder to enforce these in China (unless you have the right connections, in which case you probably don't need to go through normal courts any way).

I'm not saying it's a bad idea, and I'm all for it in principle. I guess these are really more general issues with China and her economy which incidentally apply to this than issues with the concept.

>3. It's much harder to enforce these in China (unless you have the right connections, in which case you probably don't need to go through normal courts any way).

This is a bit of an interesting question actually. Because in reality these IOU's aren't much different from a loan. And failure to pay a loan is punished pretty severely by china's Social credit system: https://en.wikipedia.org/wiki/Social_Credit_System . So in theory it perhaps shouldn't be too hard to punish people for this, but then again I don't really know too much about the chinese financial system.

"Only because of the two-currency BS they pull"

Is this really a big issue? The current spread between CNY and CNH is less than a third of a percentage point.

Capital controls in general might be keeping CNY (and CNH) stronger than it would be otherwise.

Sounds small, but it's hit as much as a 2% spread [0]. More importantly, they take this off of every transaciton. It makes FDI much cheaper for them when they go into other countries. It allows them to debase their currency internally and reap the benefits while charging others with a stronger external currency. When you factor in shadow banking etc., the exchange rate is not the same as the actual value inside China, because she is such a heavily gated market. These capital controls are precisely what pisses the rest of the world off: the whole point of the WTO and trade treaties is that you don't get to pull this garbage. When you factor in the multipliers etc. across the world, China has skimmed huge sums of cash off the top of the global market. [1]

[0] https://currenxie.com/blog/how-to-take-advantage-of-the-cny-...

[1] https://twitter.com/adamscrabble/status/1094717028009689089

Also, China is not a democracy, and much of their growth has been driven centrally. It's debatable how long it can be sustained, and it behaves very differently from open markets in an oligarchy.

Different rules apply.

It's not an awful idea, all in all.

But it's also rational to worry that it increases overall financial system leverage and that poorly-regulated pseudo-securitized debt could sustain financial bubbles and lead to worse collapses. It also creates a rather difficult problem for a credit manager being asked to accept payment in third-party IOUs.

The instruments we point at as big contributors to the 2008 housing market collapse were better regulated, rated, and more readily exchangeable than CABs.

"Commercial Paper" was a large part of the 2008 recession. Particularly, GE blamed it for lack of ability to create short term debt.

Right, if the ability to roll it over suddenly goes away, then it would create knock-on effects.

In which the NYT discovers discounted bills of exchange. Which have existed since at least the early 14th C. in Northern Italy. Sinister when the Chinese use them, though, of course.

Wait till they get a ahold of the alphabet soup of Chinese financial products:


Each with a quasi government guarantee!

Ultimately, if you're a country and you can "hide" debt, or make sure it's such a national security secret that nobody can ever know you're using tricks to hide it, you can effectively grow your country very quickly and effectively.

As long as you can cover your tracks, things are good.

And in the end, if your secret is out in the street, you don't really care because you already developed your economy, which is a huge benefit. I guess that's an advantage of what China is doing.

If that is true then the implications to monetary policy would be astounding.

As long as the debt remains between chinese lenders... That's a good way to give everybody money, and in fact that is a good way to have fake capitalism.

In a country like china where everything is in government control, without any investigative media, systematic corruption... I don't like conspiracies, but it seems like it's possible.

What if the gov just prints money and resolves these IOUs on behalf of connected people, does it have much of an effect on the economy and if so why. Is this what we are already doing ourselves in the west?

Then you would have excess money supply, and if demand for the currency stays the same, it will devalue the currency, which causes inflation. That might be OK, as long as its below your economic growth rate.

With the US, the treasury uses the fact that the US dollar is one of the reserve currencies (the euro is catching up), and the US government demands payment for their security services to Japan/Korea/etc in USD, etc,etc helping maintain the demand for the USD.

>With the US, the treasury uses the fact that the US dollar is one of the reserve currencies (the euro is catching up)

No, it is not.


Yeh the euro isn't catching up anytime soon. They don't have a strong central government or a single equity market. Until they fix that they are boned

Well I all the economy is represented by a dollar and I have the dollar I own everything. If the gov prints another dollar I've now become 50% poorer. The government essentially has taken my money. Same thing happens here. If the government prints 200 million anyone with RMB in saving will get substantially poorer and good all get more expensive.

That's not a precedent to set lightly.

Government money creation should be used for actually productive purposes. While avoiding costs represents some kind of return, it's not clear that's the best plan.

> Mr. Zhang can’t seem to get paid on time. He is now accepting the financial equivalent of i.o.u.s from as many as one-third of his clients instead of cash.

> “It wasn’t like this before,” he said. But, he added, “it’s better than nothing.”

Dude is crazy/stupid. These papers are completely worthless. How is that "better than nothing"?

When he goes grocery shopping to feed his family, do they take these i.o.u's?

I spent a lot of years keeping my money in the bank as I was always hearing news about "the next big crash is coming". I finally took the step this year to move my money into index funds and it has been going great. Last I checked I had seen nearly 20% growth in 7 months. The trade war is just making things appear so horrible but I also don't want to miss out on years of growth again.

Well, the next crash can't happen until the FOMO crowd buys stocks, now can it?

If you want to invest in the stock market, don't try to time it.

> Well, the next crash can't happen until the FOMO crowd buys stocks, now can it?

In other words, the bull market can't end until the last skeptic buys in.

If it makes you feel more comfortable, you don't have to go "all in"; it is never a bad idea to keep some cash on hand (for emergencies, etc). When the inevitable "crash" does happen, you'll be well positioned to buy some discounted shares of good businesses.

How do you know that the next crash doesn't wipe out cash savings in some way or another?

The only way cash savings can be wiped out is rampant inflation, currency devaluation, or the currency being no longer accepted. Generally "crash" refers to the stock market prices dropping. Stock market prices don't have anything to do with any of the above three, so you can be pretty sure that the next stock market crash won't wipe out cash savings. If anything, crashes tend to produce recessions, which can produce deflation, which makes cash worth more. (But, deflation is really bad, so central banks do everything they can to prevent it.)

> The only way cash savings can be wiped out is rampant inflation, currency devaluation, or the currency being no longer accepted.

Also bail-ins. Any significant amount of cash in a bank account is a sitting target if real trouble starts. This is more likely in smaller countries like Greece.

Yes. This. Greece was the test for the latest wealth-transfer mechanism. Why wait for unreliable governments to bail you out when you can just confiscate deposits?

Let's revisit this thread in few years.

We’re in guns and ammo territory then.

The bigger risk is having a large long term cash position. Large amounts of cash should have a purpose within a year or 2.

That's a bit like asking, how do you know we won't have another world war? If there was a way to know the future, we'd all be doing ___.

this is why just about everyone suggests an appropriately diversified portfolio - stocks, bonds, cash, natural resources, hard assets, etc.

Considering you should hold your index stocks for at least 10 years, you need to be able to muscle through lean times, even buying more if you can.

No retail investor can reliably profit from stock market timing. Just keep buying the index and enjoy the dip when it comes. That means the world is on sale.

I assume you are in US? But can international investor invest in index funds? If yes, what vehicle to use?

For example, my friend has investment company in British Virgin Islands, if he puts money in US index fund he ends up losing 15-20% to withholding taxes.

What are other people doing then?

Retail investors in most industrialized countries have access to index funds; Check with your local brokerage. You may or may not want to invest in US index funds and it may make sense to place a sensible portion of your portfolio in an index composed of businesses in your country (to avoid currency fluctuations). US (or other foreign) index funds may be available in your country via some sort of depository receipt arrangement.

US investors also have to pay about that much tax on any realized gains, unless they hold the funds in a tax-free retirement account.

Not entirely true since many index funds pay qualified dividends.

Is that dividend tax?

The market is at about the same level as Jan 2018.

We could just as easily be up or down 20% a year from now.

If your timing is bad, the returns from an index fund are terrible. The best advice is not just to hold for a long period (25+ years) but also not to go all in or all out.

Returns are only bad on index funds if you pull out. Historically you're getting 7% over 10 years with virtually no fees. Managed funds rarely beat 7% and have fees which reduce any gains you may have made. Better to self manage and get that consistent growth.

* this is assuming the past continues to be a predictor of the future

I think you forgot to account for dividends, and hence the total return.

That's right, I did not account for dividends.

The S&P is currently yielding under 2%.

you are in for a nice surprise next year my friend

I think I remember seeing similar comments in 2015, 2016, 2017, and 2018...

Snark aside, if your timeline is more than 10-15 years, why should you worry at all about recessions next year? On a long enough timeline, a recession is just a great buying opportunity.

Because that recession might turn into another Nikkei

Did you miss 2001-2008? Or are you being purposefully deceptive.

>> if your timeline is more than 10-15 years, why should you worry at all about recessions next year? On a long enough timeline, a recession is just a great buying opportunity.

> Did you miss 2001-2008? Or are you being purposefully deceptive.

This looks more like you being intentionally dishonest. I took DJIA figures from http://www.fedprimerate.com/dow-jones-industrial-average-his...:

    January  2000: 11,722.98
    December 2001: 10,021.57
    March    2003:  7,673.99
    October  2006: 11,850.21 (beating the high of 1/2000)
    October  2007: 14,164.53
    March    2009:  6,507.04
    December 2010: 11,577.51
    January  2015: 17,164.95
Here we have a 15-year period which starts at the high price before the period you "called out". What are we supposed to view the low points as, if not great buying opportunities?

(Also, it's pretty apparent that 2001-2008 doesn't make sense conceptually as a single period.)

Not sure, what to take away from this list of numbers. From 2000 to 2010 I see a lost decade, with the index back where it started. You added the note "beating the high of ...". why not add two years afterwards "beating the low of ...", etc.

I added the note to October 2006 because that was the only reason I included it in the list at all. It wasn't a high point or a low point, just the middle of a long rise. March 2009 is a low point.

Bezos appears to believe the market has peaked and has sold $3b in Amazon over the last week.

He sells stock every year.

He still has over $100 billion in stock.

Are you certain it's nothing to do with the divorce or Blue Origin, etc?

What time and day?

can you elaborate? thanks.

The bull market has been long. The crash is inevitable to be within a year or two. Of course various doomsayers have been vocal for a long time, but things eventually must come down.

When people like Ray Dalio are vocal about it there is something to it.

So? What if the market does crash? Just buy more index funds during the crash because after the crash the recovery is inevitable. If you are young (most HN commenters are), you can afford to wait for the recovery.

> after the crash the recovery is inevitable

It hasn't been inevitable in Japan after the early 1990s crash.

I was replying on the question what is coming next year. What you are saying is completely correct as well.

What’s different this time? In other words, how do you know the crash is inevitable within a year or two?

- There is a well-known business cycle that goes from boom to bust in about 7 - 10 years on average.

- Unemployment is at multi-decade lows; if you look at FRED graphs the unemployment hits a low right before the recession. Of course, nobody knows how low it will go, but it can't go much lower than it is now.

- Bond yields have inverted, which has been a reliable recession-in-one-year signal.

- The trade war can't improve corporate earnings.

- Maybe the trade war triggers something bad in the US and/or Chinese economy and we have another 1997.

- Any one-time earnings juice from the tax cuts is over, so the year over year comparisons are harder.

- The markets flipped out in Dec after the Fed raised rates (I think that's what it was) and dropped 20% in a week or two. The Fed made some conciliatory statements and the party was back on. The RMB appreciates by only a few percent, but over some psychological threshold of 7 RMB to 1 USD and the market flips out, dropping 3%. It feels to me like everyone is trying to pretend that the party is just getting started, but if you keep drinking, sooner or later you pass out. It's been 10 years, it's getting pretty late, people have to stop and go home sooner or later. Sooner or later something random is going to happen like in Dec and everyone is going to flip out. But this time they'll stay passed out for a while.

>unemployment hits a low right before the recession

You have your causal link the wrong way around

I want to see your do calculus for that one

Recessions make people lose their jobs

There are lots of indicators of worldwide trade slowing down. In the tech world there has been a rush of IPOs, signalling that the private funds are running dry, and so on. Companies like Ray Dalios Bridgewater track these things better then anyone. When he says that their projections point to it then there is little doubt.

If you're so sure there will be a crash within 12-24 months, are you short in the market? Short with leverage?

That’s the best thing I’ve read on the internet this year. I hope you’re at least as naive in age as your comment implies

Also called supplier financing. A risky form of loan for the supplier but great for the customer.

Factoring is very common for smaller companies. 15% for 90 days is the norm.

Looks like a credit crunch to me.

And how many trillions in "I.O.U.S" are circulating in the US financial system?

The "what about"-ism doesn't really help or work here. I.O.U's are essentially some sort of loan (with or without interest).

The point of a loan/iou is it's okay a long as you can pay later.

This works great in a growing economy. Leverage. But once things start slowing down, the pressures start to mount and i.o.u's start never getting paid back slower and slower to never - defaulting.

There's a limit how far one economy can grow and for China it's already begun to slow. These types of loans are a symptom of that.

I think the parent and grandparent comments miss the point of the article. This is basically a return to the barter system because the Chinese monetary system is not able to meet businesses needs. This should be a giant red flag to Chinese leaders.

Can you explain to me (and perhaps people like me) exactly what the problem with that is? Goods are being exchanged, so it is fine - but I don't have a huge background in financial systems. I would appreciate a different point of view on that.

"In a barter exchange one good is traded directly for another. This form of exchange requires a double coincidence of wants, meaning that each trader has what the other trader wants and wants what the other has. Without a double coincidence of wants the exchange process can become exceedingly complex, requiring a great deal of resources to complete transactions, resources that cannot be used for production. In fact, inefficient barter trading is the primary reason that money was invented." - good explanation from AmosWeb

That's almost like saying asset swaps and mortgage backed securities and all non-cash financial transactions are returns to a barter system.

...but they love Red flags?

Didn't you just describe student loan or credit card dept? Those depend on the economy growing so people can pay them back later. If the economy stops growing and people loose they jobs they will start to default on those loans.

Student loans in the US are bankruptcy-exempt.

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