China easing rates triggers economic divergence, and highlight potential distortion risks

Blain’s Morning Porridge – Jan 20^th 2022: China easing rates triggers economic divergence, and highlight potential distortion risks

“It’s too early to say..”

This morning: As the West reopens, China’s lockdowns remain draconian. It has eased rates on the back of growth concerns. The result is growing monetary divergence, and China looks set to go down the same monetary experimentation route the West is now trying to reverse.

The World and Monetary Policy has split.

As Occidental markets undergo a “fundamental” reassessment out of speculative hopes into value propositions, (thus the 10% “correction” in Nasdaq from its Nov High, versus a mild stumble in the Dow), and markets slide on the back of expectations of central bank tightening to come in the near future, the Chinese eased Mortgage rates significantly this morning, sending Oriental stocks spinning higher.

Is it time to dive back into China as it embarks on the kind of long-term monetary experimentation that has juiced Western markets for the last 12 years? Maybe not. There are a number of reasons to wonder if the Chinese will experience a very different outcome from the distortions of artificially low rates.

The first is the economics of pandemic.

The world remains riven by the pandemic – but divergence rather than coordinated economic recovery may be the end result.

The UK is preparing to end all virus restrictions. Spain has kept its doors open to tourists despite the Omicron wave. Governments across Europe are looking at case to peak this week. The USA? Never quite sure what was happening there.. although it seems it was either Dr Fauci’s fault or that he saved everyone. Across the West we are generally moving forwards, preparing to treat Covid as an endemic flu-like disease. The western economy is on the verge of coping and recovering from Covid. Growth will resume as we adjust to a new world mixing home and office working, while supply chains work themselves out… well, hopefully.

China is still closed.

The Chinese sound increasingly fearful rising rates in the West could “negatively spillover” to hit a global recovery – meaning an impact on China growth. That’s why they cut mortgage rates (the second rate cut this week), today.

Xi said it all this week at the virtual Zoom gabfest formerly known as Davos: If the west carelessly precipitates a recession from a mix of ending QE too soon, raising interest rates too quickly, or allows market failures to impact sentiment.. then China will likely pay that cost. It may be refocusing its economy away from exports towards domestic consumption, but it’s not happened yet. China’s growth still remains very dependent on the West.

Occident and Orient have adapted very differently to pandemic.

It’s a bad time to be a hamster in Hong Kong – over 2000 of the cute, cuddly little big-cheeked puffballs have been slaughtered on a whim they might be a Covid vector. Air Hostesses in HK have been pilloried for being super spreaders. The story a woman in Beijing who caught the Omicron variant opening a letter from Canada seems like a pretty clumpy way for the government to stop overseas mail and information reaching Chinese citizens, building up xenophobic fears and concerns about foreign places and peoples they disagree with as murderous virus reservoirs.

Apparently, Postal advice in China on receiving foreign mail is to don a full Hazmat 3 suit, fresh mask and gloves, disinfect the package, open outside in a well-ventilated outdoor space, dispose of packaging, and only bring the content into the house once it’s been disinfected again. Postal workers handling mail from Canada have been put in Quarantine. The Chinese don’t like Canada much.

Meanwhile, the news across China is confused. Another Chinese port was closed this week – Dalian, but others, like Ningbo have reopened. Although savage lockdowns are the order of the day wherever Covid is detected; there seem to be variations on the way different regions are treating it. Some are closing down all businesses, others are letting some stay open, but restricting lorry drivers to their cabs. Ports that have reopened are apparently empty because of a lack of lorry drivers to move freight to other parts of the country. Shanghai has week-long delays offloading ships.

China clearly has significant logistical and supply chain issues internally – and how quickly their economy reopens and is able to benefit from reopening in the West is critical. Do they simply lift restrictions in coming weeks, or is the government fearful the population doesn’t have the same built-up immunity from infections and vaccinations?

Xi’s talk at the World Economic Forum was fascinating, and it’s easy to pick out his concerns: “If major economies slam on the brakes or make major U-turns in monetary policy there will be Negative Spillovers… Protectionism and unilateralism can protect no one. They ultimately hurt the interests of others as well as one’s own… a Zero-sum approach enlarging one’s own gains at the expense of others will not help…. Way forward for humanity is peaceful development and win-win cooperation.”

The reality, whatever Xi said, is the Chinese want easy monetary conditions in the west to stimulate their recovery. Meanwhile, their shift towards domestic consumption and their pandemic response hints at increasing disengagement with the global economy – a repeating theme through Chinese history.

The Beijing Winter Olympics look likely to be “interesting” for foreign attendees.

The second big issue for China is the potential effects of Monetary Experimentation on the economy over the medium term.

2 interest rates moves in a week is a clear signal China is prepared to embark on monetary experimentation – although they will never call it that. Yet, the bursting Chinese property bubble and the default of successive developers from Evergrande down highlights it’s not necessarily more liquidity and cheap money that’s needed in the Chinese economy, (although it helps in the short-term), but more business common sense to avoid crises and bubbles from developing in the first place.

Easy money is the number one ingredient of financial bubbles.

The effects on the Chinese economy of lower rates and greater liquidity could mirror what we’ve seen in the west where monetary experimentation in the form of QE and ultra-low rates distorted markets and the efficient allocation of capital within the economy. Low interest rates fuelled speculative surges in tech, reduced investment in plant and jobs as even junk companies leveraged up to buy-back their own stock, and zombie-debt-raddled firms blocked markets to new entrants.

The experience of “communist” nations dealing with markets is patchy. The recent experience of Chinese entrepreneurs demonstrates its necessary to walk a balance between the economy, demand and the government, and being seen to not be a proud nail. The smart ones never forget success depends on keeping their “sponsors” up and down the political ladder happy.

One of key issues that is emerging from 12 years of monetary experimentation in the West is exploding wealth inequality. Inflated stock markets triggered enormous stock gains as owners became spectacularly rich as workers saw their earnings fall. If Chinese workers realise that soaring markets on the back of lower rates leaves the entrepreneurial and political classes more and more comfortable and wealthy.. and that’s likely to spawn significant issues for the CCP.

Five Things to Read This Morning:

FT – China cuts mortgage lending rate for first time in two years

Thunderer – Covid fraudsters are being given a free pass

FT – Germany’s 10-year Bund turns positive for first time since 2019

WSJ – Nasdaq Falls More than 1%, Entering Correction Territory

BBerg – The UK is Two Months Away From a Brutal Cost-of-Living Crisis

Out of time, and back to the day job..

Bill Blain

Strategist – Shard Capital