US markets, despite the regular technicals which to a large and generally misunderstood degree drive early January activity, went into the release of the Federal Open Market Committee’s December minutes wound up like a spring. What was delivered was, at least as far as those who were panting with anticipation were concerned, a fairly anodyne wet squib. Nothing to see here. Thus, risk asset markets sold off albeit not by a lot. This was most likely in mild disappointment over the lack of fireworks rather than for any notable reason although the quick and easy excuse will be the disarray which reins in Washington where the election process for the Speaker of the House, a role which elevates the elected individual to “third in line to the throne” behind the president and the vice president, remains stuck in the mud.
Civil war is raging within the Republican caucus. At the beginning, the recalcitrant anti-McCarthy right wing group looked a bit like a bunch of little children throwing themselves on the ground and drumming their feet. Yes, we’ve heard you, now let’s move on. But not so. The kids have superglued themselves to the floor. The GOP, the Grand Old Party, is now looking like a nursery school and a GOM, a Grand Old Mess. Today is Epiphany which perchance also marks the second anniversary of the Capitol riots and the storming of the building. I noted at the time that it is far from being the first parliament building to have been stormed by protesters and that the Capitol, although the seat of government, is surely not the seat of American democracy. That is vested in the people and not the place. As unedifying as the spectacle was, like so many things American, its relevance to the big picture was overblown by the media and it has turned into another monumental partisan dog fight, the type of which is turning the government of the world’s most powerful nation into a laughing stock and a third rate soap opera.
Until America can find a way of setting stringent and meaningful spending limits on campaigning for office, it will continue to be exposed to the risk of corruption, financial and moral, on a grand scale. The role of leader for the Western world must cease being for sale to the highest bidder. But that is another matter and, just to be clear, no excuse for markets which already feel a little directionless. Not that someone won’t pop up and try to weave the House deadlock into the picture. If one wants to see what real political influence means to the economy and to markets, look no further than Beijing where it appears as though the “three red lines” are about to be shelved.
The three red lines were imposed by the administration in response to the growing problems within the real estate sector, the crumbling of the giant Evergrande of which was the most visible element. They are in order: 1) a liability to asset ratio of no more that 70%, 2.) a net gearing ratio (debt- equity divided by shareholders’ equity) of less than 100% and 3.) a cash to short-term borrowing ratio of at least 1. If nothing less, the imposition of the three red lines did much to keep the flies off the bride. The focus on the problems which looked like they might launch a domino stone like collapse of the sector and a bursting of the residential real estate bubble seemed to have been turned from looking for the worst case to estimating the best one. China’s ailing real estate market was suddenly no longer going to bring down the entire economy along with the highly exposed banking sector. The heat was off.
All the while, not only China watchers but macro economists the world over were left wondering what the impact would be of the Chinese construction industry winding back? China in 2023 is not China in 1998. Twenty-five years ago the construction industry was the greatest driver of growth and 70% of GDP was to be found in construction and manufacturing. That has now dropped back to 44% with the tertiary sector having become the largest in the economy. Agriculture has fallen back to 11%. That said, although the percentages have slipped, the actual numbers have grown exponentially.
To most of us, China remains a mystery wrapped in an enigma, especially to my own generation which remembers it as a deeply impoverished third world country hidden behind Mao’s “bamboo curtain”. It began to emerge in the aftermath of the 1971 table tennis world championships which had been held in Nagoya, Japan and which resulted in the US team being invited to play in China. Thus the term “ping pong diplomacy” was coined. In February 1972, President Nixon followed the path beaten by the athletes and flew to meet Chairman Mao in what we then still called Peking. To us the eye-watering speed at which the country has leapt forward remains, and I mean this, nigh on impossible to get our heads around. The grainy pictures of the era of the Cultural Revolution and of bunches of students waving Mao’s Little Red Book – actually it was to us black and white – and chanting ideological phrases remain imprinted on our memories. How did they get from there to here?
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The answer is by hard work but also by cutting certain corners. The economy has developed at a speed which, if looked at critically, can in no way have generated sufficient organic value added to fund itself. The second half of the answer, therefore, is by a massive state sponsored expansion of the money supply. The Western debt problem is the result of households and government quite simply living beyond their means and although we know it is wrong, nobody is really prepared to grasp the nettle. That was clearly displayed when in the aftermath of the 2007/2008 debt crisis politicians and business leaders could think of no better way to tackle it than by borrowing their way out and by piling up more debt.
In China the situation was very different, for everybody could see that whatever debt was being accumulated was being invested in hard assets and infrastructure. Nothing wrong with that! GDP was growing exponentially and happy times. In the year 2000, US nominal GDP stood at US$10.252trn as opposed to that of China which was US$1.211trn. That’s roughly one eight. By 2011 the numbers were US$ 15.542trn vs US$7.551. According to IMF estimates, the 2022 figures should read something like US$ 24.003trn vs US$18.013trn. The rapid slowing of Chinese growth has put a stick in the spokes of the extrapolations which had China’s economy overtaking that of the US by this year or next but the gap will in one way or the other continue to close. Given that China has three and half times the population of the United States, should that come as a surprise? In terms of PPP – purchasing power parity – Americans still produce on average nearly four times as much as their Chinese peers.
President Xi, whilst swinging himself into absolute power at last year’s party congress, found himself caught in the zero-Covid straitjacket of his own making and I recall predicting through most of the summer that said zero strategy would not be lifted before the congress but that it would most likely not survive for long once Xi’s anointment had taken place. It might have taken a couple of months but now we have it. The street protests which, if not as such having brought about the scrapping of policy, will certainly have accelerated it will also have reminded Xi that public uprisings are not good for his image as the steady and loving leader. The damage to the economy which the lockdowns had inflicted now need to be reversed as quickly as possible and what better way than to reinvigorate the construction sector?
Scrapping the three red lines is nothing more than selling the life jackets in order to buy fuel for a boat which is already shipping water. But do we care?
Over the weekend it leaked out of Beijing that the sanctions on Australian coal were to be lifted. During the hiatus, China has been importing Indonesian coal which might have replaced the tonnage but is of higher sulphuric content and not really suitable for the manufacturing of high quality steel. Reopening the market for Australian coal already indicated that steel production is going to be ramped up. The removal of the red lines reconfirm that impression. Xi is indisputably preparing a dash for growth. Mining stocks from Antofagasta to BHP are bid to buggery.
That said, my longstanding opinion that China is uninvestable is not reversed by this development but reinforced. It will pour oil on the fire and it is hard to believe that the situation which has been stalking China’s property sector will not in fact and over time become more acute. On the other hand it might be argued that Xi and the CCP will prop up the economy at any price and that only an idiot would not want to be there as long as that does not change. Pays yer money, takes yer choice.
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