“What Happens Next? Nobody Knows – But It Doesn’t Look Good At All”

By Michael Every of Rabobank

Dire Straits

So, there is no longer any Nancy Drew Mystery. US House Speaker Pelosi will be in Taiwan today, says Bloomberg; she will meet with President Tsai Ing-Wen on Wednesday, says the Financial Times. That is no real surprise given Pelosi’s track record –she visited Tiananmen Square in 1989 and was arrested and detained– and given going was the better geostrategic damned-if-you-do-damned-if-you-don’t choice.

What happens next? Nobody knows – but it doesn’t look good at all. Let’s unpack why.

First, those who have kept their heads in the sand are forced to wake up and smell the deeply unpleasant coffee. There has been a lot of that in 2022. There is *a lot* more to come yet, e.g.,

“There are no war risks over Taiwan.” No, there always were. Until the geopolitics is resolved (how?), there always will be.

“Markets are wrong to link Russia-Ukraine to China-Taiwan.” Because I don’t want to have to shift more of my portfolio or supply chain.

“Markets haven’t moved yet.” As I said around 24 hours ago in a work chat, they will as soon as Pelosi arrives or confirms she will arrive. And here we are.

Second, those who were aware of the above issues but were out of the news loop are having to play rapid catch-up. That apparently includes US Secretary of State Blinken, who stated, “We don’t know if Speaker Pelosi plans to visit Taiwan or not.” Is the White House also in the dark?

Third, we have to consider who is responsible for driving this crisis.

On one hand, the US. If Pelosi wanted to visit Taiwan, she could have just turned up, giving China no time to object, and no rope to hang itself with over its public framing of the issue. The White House could also have blocked Pelosi logistically, not constitutionally. Was this a screw up, or a deliberate ratcheting up of tensions? Hard to say, as this administration blows hot and cold.

It has been flirting with removing China tariffs for absolutely zero quid pro quo. At the same time, it is talking about ‘friend-shoring’ from China; backing the Quad; and AUKUS; and a G7 rival to China’s BRI; and a new Indo-Pacific trade bloc to exclude China; and the Blue Pacific Act to push back against China; and the new I2U2 group to draw India into the Middle East as a counterweight to China. Plus, the open threats of what happens if China helps Russia in Ukraine, and President Biden publicly promising to defend Taiwan if it is attacked, which has had to be walked back by the White House each time.

On the other hand, China. It knows the US sends senior officials to Taiwan all the time. It knows US marines have been training Taiwanese troops. It knows the US sells weapons to Taiwan. It knows the US just re-pledged its commitment to the “One China” policy. It knows that President Biden opposes Taiwanese independence – yet Beijing is now saying that a Pelosi Taiwan visit undermines that critical independence redline, which everyone takes as a trigger for action.

Equally, China knows if it makes a huge fuss, the US then cannot back down. So why is it making so much more a mountain out of a Pelosi-sized molehill? Is it all about the November Party Congress? Does that constrain Xi – or actually free him to act more aggressively on many fronts?

Keep that framing in mind as we lastly consider what might happen next.

“China won’t act militarily because its economy is in trouble,” as I heard yesterday. Which, historically, can also mean the complete opposite. Especially when foreign-policy messaging –“Don’t say we didn’t warn you!”– is the same as before wars vs. India and Vietnam, and when that parallel is underlined in English for the China experts who can’t read Chinese or its history. Also consider that Chinese public opinion appears firmly in favour of a strong nationalistic response to the US ‘provocation’. I just got a message from a China-following friend with close contacts on the mainland who track local social media: “The smell of war is so potent.”

Back to the US side: “We will not take the bait or engage in sabre-rattling,” says the White House press secretary. “ At the same time, we will not be intimidated.” That smells too.

So, buckle up, buckaroos. In short, much more volatility potentially lies ahead this week: yields will likely go lower; stocks may try to use that as an excuse to bounce higher – unless they have any direct or indirect China linkage, which means just about everyone in the US; safe haven FX will get more safe-haven-y. And anyone using Chinese supply chains arguably has even more need to consider not doing so as soon as possible.

Moreover, volatility will likely last far longer than this week, even if the attention span for many in markets won’t. Indeed, the Pelosi visit risks rapidly metastasizing into a Fourth Taiwan Strait crisis.

For those who think Taiwan is Thailand, the First Taiwan Strait Crisis (1954-55) saw open fighting between the mainland and Taiwan, and China only backed down after US nuclear brinksmanship. The Second Crisis (1958) saw another round of fighting, and again there were risks of nuclear escalation before China backed down. The Third Crisis (1995-96) saw China lobbing missiles, and the US sent an aircraft carrier to force China to back down.

What is the resolution to a Fourth Crisis against a much stronger China demanding Taiwan return to the mainland and threatening force to achieve it? US aircraft carriers no longer seem to intimidate,… so nuclear escalation? Or the threat of economic warfare? If so, from which side?

This is like Russia-Ukraine and the Northern Ireland-Irish border rolled into one: an intractable problem that has no good solution once key political compromises are deliberately taken off the table. The only question is whether we get a Russia-Ukraine or a UK-EU style ‘resolution’ in the short and long term. Or what colour sand you want to put your head into to ignore this uncomfortable fact and keep trading regardless.

Meanwhile, things are also far from happy in the general world economy – but again, that doesn’t mean worse things can’t happen just because it will ruin your August holiday.

German retail sales just collapsed the most on record, down 9.4% y-o-y in value terms and 8.8% m-o-m in volume terms. If sustained, that isn’t a recession, but a depression. The EU manufacturing PMI saw a sub-50 reading again, and while the US ISM survey rose to 52.5, prices paid collapsed to 60 from 74.3, and the gap between new orders (48) and soaring inventories was even more worrying. Indeed, the Atlanta Fed is close to showing the US is on the cusp of three consecutive quarters of negative growth: Paul Krugman will then explain (via fax) that this still isn’t a recession, and it still doesn’t matter if it is.

Relatedly, I just looked back at a New York Times Magazine article (‘On Language’) from 1982, which seems a very different time, world, and media. It notes:

“[In 1977] When Alfred Kahn, Jimmy Carter’s chief inflation fighter, used the politically taboo word ”depression” in a statement from the White House, the economist was pounced upon by assorted communicators and soothing-sayers; as a result, the hapless but happy man pledged to substitute the word ”banana” for ”depression” in any future economic message.

Here we are, five years later, and many people fear a deep, full-fledged banana. In fact, some who write about the economy… have broken the taboo: We are witnessing a boom in the outspoken usage of the word ”depression.”… This unabashed public use of the dirtiest word in economics led to its prompt adoption by the media…

The tossing about of such a word is both political and linguistic news. When the word was flung at Franklin Roosevelt during the mid-1930’s, he waggled a finger at opponents and told them not to speak of rope in the house of a man who had been hanged: ”If I were a Republican leader speaking to a mixed audience, the last word in the whole dictionary that I think I would use is that word ‘depression.’ ” About that time, ”recession” came into being, replacing the odious ”depression,” a word that Henry Vansittart first applied to a slowdown in 1793, and that Aldous Huxley resuscitated in 1934.

Prof. John Kenneth Galbraith informs me that the word first used widely in this regard was ”panic”; Karl Marx later preferred ”crisis”; ultimately, a much softer term –”depression”– was chosen, so as not to panic the crisis-prone. However, the euphemism ”depression” came to be remembered as the moniker for the terrible times it described, and thereby gained a fearsomeness of its own. ”A depression,” says Dr. Galbraith, ”is something that in social memory has taken on the dimension of a disaster.”

Since then, hard times have been euphemized as ”rolling readjustments,” ”crabwise movements” and ”extended seasonal slumps,” but it seemed that linguistic order was just around the corner when the National Bureau of Economic Research defined a recession as ”a recurring period of decline in total output, income, employment and trade, usually lasting from six months to a year and marked by widespread contractions in many sectors of the economy.” Journalistic shorthand reduced that definition to ”a two-quarter decline in gross national product.”

And then it all went bananas again.

Indeed, some are trying to sell what is happening now as a “transition”. Can we perhaps all agree Dire Straits summarises all of our collective global problems and leave it at that?