The Russia and Chinese Crises facing markets are of different magnitudes

Blain’s Morning Porridge April 28 2022 – The Russia and Chinese Crises facing markets are of different magnitudes

“Contradiction and struggle are universal and absolute, but the methods of resolving contradictions, that is, the forms of struggle, differ according to the differences in the nature of the contradictions.”

This morning: Ultimately the economic history books will record Russia’s invasion of Ukraine as a speedbump, and perhaps a triumph for a United Europe. The consequences of an Economic War with China could be much, much more significant!

The locus of market attention is no longer Ukraine – its China. The Middle Kingdom’s questionable lockdown strategies are raising a host of consequences and implications that are moving markets as strongly as Russia’s invasion of Ukraine did in February.

Earlier this week, markets tanked as new China lockdowns were enacted. It’s likely more restrictions will follow further stressing supply chains. Yet, it’s no longer really about Covid. It’s about the post-Covid, new geo-political economic future – and where we all fit in on that. Russia will likely prove a historical blip. In contrast, China will likely prove a much larger and longer-term headache for markets and the global economy.

Let’s compare and contrast the two crises:

Russia

Ukraine has highlighted the abject failure of the Europe’s long-term energy security. It’s triggered a wave of inflation leaving central banks ill-equipped to tackle a real-world crisis that requires enormous infrastructure build out and investment – when their only tools are questionable monetary policies like a few points on interest rates or renewed QE. It’s created a wave of food instability that will trigger further consequences across the Emerging Markets.

The critical point is – Europe will likely deal with the challenge. In simple economic terms Europe crushes Russia. Militarily – the events of the last 60 days demonstrate we have less to fear than we thought. Europe benefits from the support of its Allies, primarily the US, and is a major economic block in its’ own right.

The EU’s economic stability is two-fold. Partly it depends on the domestic politics of each nation gains from supporting common purpose – something we Brits simply didn’t understand or accept. The signs are good after Europe quickly came together following the invasion. But, it also depends (in part) on the ECB holding the fraxious tribes of Europe united within the Euro.

The ECB is a hybrid – it’s a political central bank. Don’t bet against the ECB bending over to enable solutions, compromises and accommodations. I has to – and its fortunate its last two Presidents have proved accomplished politicians. The monetary politics of Europe will remain convoluted, messy and probably not without many challenges. Its’ not without risk, but I will bet on Europe succeeding rather than Russia.

Be realistic about Russia:

• Yes, it has the potential to become a rogue nuclear power.
• But, Russia is not a long-term economic threat.

It is not a significant economic force. 30 years of political failure and the emergence of the Putin Kleptocracy since the breakup of the USSR leaves Russia ineffective – except in non-human resources. It’s increasingly obvious it shot its bolt at Ukraine, where its armed forces have been found wanting. Its spiralling demographic decay will leave it will be irrelevant in a few decades. But it has to be crushed today to restore economic stability to Europe.

Putin chose this war. Russians will pay the price, but they are not stupid. When Putin is gone, sooner or later, the next Russian Warlord, or the one after that, will realise re-engagement with the West is in his (or her) personal interest, blame it all on Putin, and try to rescue what they can as they get hit for war reparations.

I suspect Russia will then open up to global markets, where global players will squabble about how to divvy up its vast mineral and commodities reserves. The mistakes of the oligarch era will not be repeated – Russia will undoubtedly find new ways to screw themselves up. Without minerals, oil and gas – Russia would be utterly irrelevant – and they know it.

Nobody to blame but themselves.

China

China is anything but economically insignificant. But it is in crisis.

Russia we recognise as vaguely European. China is not. Its different. Yet, essentially it faces much the same problems as the West. Its been an investment disaster these past two years, and many analysts now say China is uninvestible. It feels that way looking at my portfolio. That’s why its worth looking again.

The immediate China problem is about the very nature of global trade itself. With China closed, all the consumables, materials, products and widgets the West relies on – our iPhones, Telsas, parts and a host of other “goods” will become largely unavailable. Broken supply chains have triggered massive debates on how the west can regain control of its economic future – which is hardly optimal in service led economies that depend on imports.

Yet, China faces much the same problems as the West has faced. It is struggling with the consequences of Covid Lockdowns. Externally, these will damage global trade. Internally, China has a host of problems to deal with – the over-importance of the ailing property sector, recurrent banking instability, and now the consequences of the overblown punishment of its leading big tech firms damaging its outlook – the mini-cultural revolution the crackdown was will hardly going to inspire the next generation of tech entrepreneurs.

There are some great comments in Robert Armstrong’s FT piece this morning China’s Impossible Trilemma: “China can’t lock down, hit its growth target, and stop buying growth with debt all at the same time..”

President Xi will no doubt secure his third term as Emperor, but he’ll be acutely aware that the CCP relies on a compact with the populace to deliver jobs, prosperity and peace. Break that and social tensions rise. (No such compact exists in Russia.) He’s aware that balance would be profoundly upset by an economic strike against China – the effects of the weaponization of the dollar will not have gone unnoticed in Beijing. He’ll also have noticed the actute underperformance of the Red Army, and wondered what that means for China, where the PLA’s cadres work on essentially the same basis of top-down authority. He’ll understand China’s future prosperity would benefit from continuing to sell 70% of the goods offered on Amazon, and access for Chinese consumers to Western goods.

Xi has the opportunity to avoid the mistake Putin walked into – giving the West the excuse to crush his economy.

Perversely, the main Economic threat to China is not how it interreacts with the West, but how the West perceives it.

China is seen to clearly favour Russia over Ukraine, therefore it’s perceived as a clear enemy. Many other nations have also declared themselves neutral, but are favouring Russia (many because of perceived threats by America), but we are still trying to woo them. India, the Gulf and others are perceived in a different light to China. There are trade and geopolitical reasons – like oil – we do so.

But the Western narrative – the one you can read in the press – is about hostility. It treats both Russia and China as clear threats. Both as painted as Enemies of the West. That’s a massive danger. The iteration of the famous Thucydides Trap – where the world’s leading power will inevitably go to war with the emerging power threatening its position – seems more and more likely to be fulfilled.

War with China would be significant, and the economic consequences a couple of magnitudes higher than war with Russia. Let’s not go there.

Let’s look for the optimal economic outcomes instead – which remain achievable. The Chinese leadership are not stupid and we can assume they see the long-game.

I’m not so sure I can same the same for Washington. That’s a serious point – not a Blain jest. Will US politicians be able to see past their partisan lines and spot the opportunities for peace and growth when gridlock dominates and their primary concern is to rubbish each other..? Negotiating with China is not about headlines but long-term. Think Go/Weichi rather than the noughts and crosses Trump thought he was winning as he blagged about trade negotiations.

The World is an imperfect place.

The stories coming out of China on the horrific lockdowns magnify the narrative – killing household pets, quarantine, dynamic clearing of covid suspects (confirming its now a crime to be ill in China), are one aspect of the negative narrative. Economically, its about blocked ports, the unreliability of the economic data, and broken internal supply chains (as lorry drivers can’t move) – all reinforcing the view China is failing to cope with Covid. And, some of the newspapers can’t resist spicing up the story with how China is now reaping the rewards of the global virus it unleashed on the world.

Forget the narrative. Look at reality.

This morning’s Five Things to Read are all background on China

BBerg – Xi May Soon Learn You Can’t Eat Statistics

WSJ – Beijing Sticks to Strict Covid 19 Measures As China’s Cases Drop to Three-week Low

BusinessWeek – Doubts Grow Over Chinese Statistics as Covid Ravages Economy

Guardian – China cracks down on price gouging amid food shortages

WSJ – Xi Pushing to Beat the US in GDP growth Despite Covid Lockdowns

Out of time, and back to the day job…

Bill Blain

Strategist – Shard Capital