If in doubt, just zoom out...
There's plenty of doubt around right now.
News is coming thick and fast, but not really clarifying much about the future path of... anything.
One dominant theme is China, their economy and their relationship with the rest of the world...
Trump's greatest achievement was putting the spotlight on China.
It wasn't that he revealed anything particularly new, but he was a very high profile messenger and once enough people knew, the rest was history...
It's all going on over in Chi-Na.
But the only thing everyone agrees on is that China is entering a transformational period.
It will either be amazing or collapse. Black or White.
Shades of grey were banned by the American media association & the CCP.
There is nothing in between.
The bull case for China is their maturing economy and the transition from manufacturing-led to consumer-led.
Basically this 👇
Simply, China will outgrow their debt whilst managing the exchange rate and speculative bubbles and this middle class growth will lead to an increase in consumer spending.
Greater wealth will lead to higher equity prices, the blissful union between communism and capitalism will be realised and prosperity will be widely shared...
OK, maybe I went too far.
But that's the general gist.
Essentially, China will prosper in the coming years.
But there are a lot of parallels between China today and Japan in the '80s.
Another rising power in the East, challenging the U.S. economic dominance...
- 1985 Plaza Accord devalues the dollar leading to rapid appreciation of the yen
- 1986 Japan’s export and GDP growth flatlines
- Recession & rapidly appreciating yen leads to large fiscal stimulus
- Interest rates are slashed
- 1987 Japan’s output was booming, along with credit growth and asset prices. Stock and urban land prices tripling from 1985 to 1989.
- 1990: The stock price bubble burst. Share prices lost a third of their value within a year, and two decades of dismal economic performance followed
Can China avoid Japan's fate?
Aside from the CCP's motivations of centralised control, China's attempts to control capital flows, manage their exchange rate, and quickly stamp out speculative bubbles are heavily influenced by lessons from the Japanese bust.
It's also why they don't want to lower interest rates unnecessarily.
Apparently, low interest rates fuel speculative bubbles. Who knew?
Going deeper, much of China's approach is explained by Mundell's impossible trinity (or trilemma triangle) 👇
People may want them to pick a side of the triangle and just get on with it, but rapid change won't end well, so China prefer to loosely bounce around inside the triangle.
Gradually withdrawing FX intervention and moving towards a free-floating Yuan is the main game.
(Heavy emphasis on gradually and towards)...
Note that the PBoC intervened again to slow the Yuan appreciation yesterday 👇
They had been jawboning lately, and the latest intervention comes in the wake of weaker PMI data, with higher commodity costs especially weighing on smaller exporters.
New export orders slipped to 48.3 in May, down from 50.4 last month.
Small firm activity slowed too, down to 48.8 in May from April's 50.8.
Likewise, the Caixin PMI noted that the price transmission effect emerged as manufacturing output prices surged. Rapidly rising commodity prices began to disrupt the economy as some enterprises began to hoard goods, while others suffered raw material shortages. Supply chains were also significantly affected.
The bull case in a nutshell: China will be successful in managing the risks, gradually allowing the yuan to appreciate, gradually opening up further to foreign investment. The middle class wealth growth will lead to a consumer boom & the economic growth outweighs the debt burden.
The bear case is a long list of well-known risks, which are well covered here 👇
- Huge unproductive investments
- High debt levels across government & corporate sectors
- Slowing economy
- High cost of living
- Ageing society
- Underdeveloped banking sector
- Overdeveloped shadow banking sector
- Suppression of creatives/entrepreneurs
- Increasing international isolation
- The widely held belief that state-supported/owned enterprises cannot fail
They might be Hua-wrong about that...
Then there's the property market...
That's before we get into all of the political risks surrounding Taiwan, China's 'Wolf Warriors' making more enemies than friends, Xinjiang human rights abuses and so on...
There's also the question of entrepreneurial spirit being killed by central planners...
All of these themes have different durations and implications.
More immediately, China's credit impulse has turned negative, which isn't usually good for commodities, (although some argue that the U.S. will be pick up the slack here...)
Suddenly, the lab leak theory is 'looking plausible...' too
In March last year, it was widely agreed by everybody sensible, me included, that talk of the pandemic originating in a laboratory was pseudoscientific nonsense almost on a par with UFOs and the Loch Ness monster.
Guess I'm not sensible then!
Hanlon's Razor: Never attribute to malice that which is adequately explained by stupidity
I doubt we'll ever know for sure, but it's a handy little pressure point for the world to press on, together with the Xinjiang violations.
Diplomatically, China is cautiously extending olive branches...
It's hard to see much changing in the near term.
Whilst China is more recognised as an economic competitor these days, it's also a huge trade partner for large economies and this dual-reliance takes time to unwind.
China also has a big demographic problem...
They might as well increase the cap to 20 for all the difference this will make 👆
Among those measures, China will lower educational costs for families, step up tax and housing support, guarantee the legal interests of working women and clamp down on "sky-high" dowries, it said, without giving specifics.
It would also look to educate young people "on marriage and love".
China had a fertility rate of just 1.3 children per woman in 2020, recent data showed, on par with ageing societies like Japan and Italy and far short of the roughly 2.1 needed for replacement level.
"People are held back not by the two-children limit, but by the incredibly high costs of raising children in today's China. Housing, extracurricular activities, food, trips, and everything else add up quickly," Yifei Li, a sociologist at NYU Shanghai, told Reuters.
It's clear that China are entering the most challenging period of the past couple of decades, and they will be hoping to be in the headlines for more of the right reasons... 👇
There is no return for the CCP.
The old 'we can build it cheaper than anyone else' regime is less viable as labour costs increase alongside an increasing cost of living.
Achieving this transition whilst deleveraging is a monumental challenge and China's rise or fall (and everything in between) will have a huge impact on the investing landscape for years to come.