Not a Bazooka

Or an easing cycle either........

The latest moves by China have got the noise markets very excited, with some sharp spikes in share prices in the last few days and the emergence of a new narrative about an easing cycle. We would disagree with both sets of analysis, to wit, the Fed is not going to cut rates aggressively, think rather of no longer keeping rates above the ‘natural rate’ and is in fact easing only as far as neutral. It has no wish to find itself stuck again in the misallocation-of-capital world of QE.

Secondly, the Chinese have never sought to manage their economy by ‘stimulating consumption’ through encouraging consumer indebtedness and they aren’t about to start now. The narrative of a ‘bazooka’ comes from the same school of hyperbole that brought us the ‘pivot’. Talking their own book is the most polite way of putting it.

Investors who are able to invest in China should definitely consider doing so, not because there is going to be a giant stimulus (there isn’t), but because the historic mis-reading of the Chinese economy as ‘doomed’ has left tremendous value opportunities and the current wave of short covering and trading noise will settle down and hopefully form an investable base.

China needs a stable stock market for the next phase of its financial development, but that is not the same as bailing out leveraged speculators, just as it wasn’t with the property developers.

The China initiatives are about providing liquidity to allow excess supply to clear at lower prices - not about ‘stimulating demand’ to allow producers to remain profitable

Our analysis is based on a few long standing views on China and the Chinese economy

• China is not a traditional emerging market and has not and will not follow the traditional model imposed by the Washington Consensus - which is the template for most economists’ models. (See previous post: the most powerful man in the world) In fact it is following Charlie Munger’s policy of inversion, it looks at the US and the emerging markets and mostly, quite literally, does the opposite of what it sees as terrible policies.

• In 2012, Xi said that where the market can set prices it should be allowed to do so, while at the same time Western governments are constantly trying to ‘fix’ things by fixing prices - notably the price of money, the price of energy and the exchange rate. It is a fundamentally different approach. Falling prices are part of a market clearing process not a signal to increase demand. This is creative destruction, something the west have forgotten.

• China is building an economy, whereas the west is trying to manage what they have already got. The US has 600,000 bridges of which 46,000 are deemed to be ‘structurally impaired’ and it is estimated it will take to 2070 to fix them. China built 46,000 bridges last year. GDP is thus an output, not a target or a KPI - a good 4% is better than a manipulated, leveraged 5%.

• The Chinese stock market is not important for wealth, nor for capital formation - at the moment. China has excess savings, low indebtedness and holds Gold and property as a store of value. Analysing the Chinese economy through a western lens in order to predict policy misses these key balance sheet differences.

The following is from a reply to a comment on an earlier post and I thought was worth repeating here.

All countries have problems. For investors, it's just a case of how the government responds. Part of the reason for setting out the laundry list (Edit: youth unemployment, aging population, housing crisis etc) is that it is the one handed to the media by the US government - and repeated widely in the Economist, FT, Bloomberg etc. as a way of defending its Economic model and discouraging the rest of the world from following China. Not to indulge in whataboutery, but the youth unemployment is actually a small cohort, around 6% of the workforce and has much to do with graduate unemployment. Graduates are far more vocal than say the much higher proportion of the workforce that is in the equivalent cohort in India (where the unemployment rate is far higher as well).

The crisis is not in Property, it is in property developers and the government is bringing in policies to clear the excess inventory that does not involve free money for Wall St. A lot of western investors speculated that the Chinese would come in and rescue the developers last year and bought the debt at 7c on the $. The smart ones got out at 70c a few months later, while the rest are back at 7c. In the meantime 150m have moved from the countryside and been housed. That was the policy. New cities have been built, people have moved, the infrastructure is there and there are no favellas.

The western way of looking at the economy is to say - exports are x% of GDP, therefore they need to cut the exchange rate to boost GDP, or that Investment is y% of GDP and thus when they stop building housing and infrastructure GDP will collapse or that Consumption is z% of GDP and thus they need to encourage more consumption to get GDP up. Everything is about a KPI of GDP and everything 'recommended' by IBs to achieve it is about making money cheaper. Funny that.

This is managerialism - like corporate managers leveraging up the balance sheet to generate an EPS number. Western politicians - advised by consultants and economists do it. China doesn't.

They will not cut interest rates to stimulate the economy - the knee jerk recipe from western 'economists' because they understand that manipulating targets with leverage is unsustainable. Indeed, they recognise that GDP is an output, not a target. In this instance they also know that with 96% home ownership and very little household leverage, this is not a good way to run a balanced economy.

This is why they never did QE, it is also why they don't set crazy targets for 'net zero' - they want to reduce roadside pollution (a huge issue) so they build EVs, that also reduce the need to import oil (another huge issue). They have a balance of renewables - wind where it blows, solar where the sun shines that are backed up with coal and gas., They also have small modular nuclear and every aspect of the energy transition complex aimed at making power cheaper. They don't set out to 'create high paying green jobs' that end up crippling actual job creation.

Manufacturing efficiency is about utilising technology - the AI in China is going into Robots, not into creating fancy images and writing news commentary - and the supply chain effect is powerful - which is why VW and Mercedes are building there.

As to savings and consumption - that is the next step. All Asian countries have excess savings, much of which is in relatively unproductive assets and building an investment infrastructure is a key long term goal. Right now China doesn't need any more domestic savings to fund its investment, just as it doesn't need any more $ to fund its energy costs, so wages will ultimately feed through into consumption - just without the dangerous turbo charge of consumer credit - the driver (and now Achilles heel ) of the 20th Century 'west.

Finally, the 'security threat' from China is an almost entirely US manufactured artifice to enable them to avoid their own rules and try and limit China's economy. Unfortunately for the US, these sanctions are actually making China more efficient and damaging companies like Apple and even the might Nvidia - note that the Chip Nvidia is 'allowed' to sell in China has already been beaten by a new one from Huawei that was supposed to take 5 years to develop but took 5 months. They are cutting prices to compete. As are Apple and while there is little demand for a $130k Taycan, there is plenty for the $30,000 Xaomi lookalike. Same across almost every product line. The US can bully the EU into sanctioning China to protect (mainly US) western manufacturers, but they can't force the rest of the world to. To that extent, China is challenging the world order, but the push back is coming from the US. The rest of the world is on board.

Bottom line, China is ensuring there is enough liquidity for local government and households to buy up the excess inventory in the housing market, it is not about to stimulate another wave of housebuilding. The bounce in iron ore and mining stocks or Chinese retailers is short covering, not predicting a new wave of demand.

The government is no more interested in bailing our steel companies than it was in bailing our property developers, but it still needs copper and steel and there are still 100m people involved in construction.

Ultimately the Chinese government needs a stable and efficient stock market to transition savings into investment as it builds out long term infrastructure and some of there latest announcements will help in that ambition, but it is not trying to manipulate a wealth effect with some version of the Greenspan put. Having said that, borrowing at 2% and buying a basket of higher yielding China stocks is probably the new carry trade that Warren Buffet is looking at right now…..