China's Wealth Mgmt Products wobbling
Now China is about to set the world record with a $9 trillion Ponzi. Here’s how it works…
The Chinese have a middle-class of several hundred million people with a high propensity to save. Most Chinese don’t get to invest overseas, so they are limited to real estate, gold and local investment products, mostly sold through banks.
When customers go into a bank, they are offered a standard bank deposit paying about 2%, or a “wealth management product,” (WMP) that pays about 8%.
WMPs are something like the collateralized debt obligations (CDOs) that brought down Lehman Brothers.
Many customers naturally take the 8% return and invest in bank-managed WMPs. Customers believe the WMPs are guaranteed by the bank or the government. They’re not — WMPs are just unsecured investments.
WMP’s have been described by the former Chairman of the Bank of China as the greatest Ponzi scheme in history.
It gets worse…
The banks use sales of WMPs to invest in the riskiest development projects and state-owned enterprises (SOEs) on the edge of bankruptcy.
These institutions behind these projects, financed by the original WMPs, cannot repay them. So most of the WMPs will never be repaid.
Banks rely on sales of new WMPs to redeem the old ones at maturity. Today, when a customer wants his money back, the bank sells a new WMP, and uses that money to cash out the redeeming customer. The new investor steps into the shoes of the old with the same bad underlying investment.
What happens when everyone wants his money back at once, or new customers just stop investing?
That’s what happened to Madoff, and that’s what will happen in China. Even China’s $3 trillion in hard currency reserves won’t be enough to cover a $9 trillion panic.
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