“One Wonders Who The Real Morons Are”

By Michael Every of Rabobank

Hu’s who and what’s what

For some, today’s big news is former British PM BoJo dropping put of the Tory leadership contest, marking the coronation of former Chancellor Sunak as the next national leader. There will be chatter of what this means for the UK’s “moron risk premium”. Yet given markets, central banks, and actors like Sunak built a global system that is not only not failsafe, but which is de facto designed to fail in terms of healthcare, supply chains, inflation, energy security, financial stability, the environment, and even national defence, one wonders who the real morons are. As Taleb might put it, those talking about MRP hold their own Intellectual Yet Idiot (IYI) risk premium, which ironically they aren’t pricing correctly, e.g., Friday already saw a spike in key bond yields and collapse in JPY, requiring central-bank interventions that won’t resolve things at all.

A good winnowing mechanism of knowing if you are dealing with an IYI is if, given a free choice, they focus first on the Sunak story, and not on what happened in China over the weekend.

Xi Jinping was reappointed Secretary General of the Chinese Communist Party for another, unprecedented five-year term: as age-limit rules were broken, and the party constitution rewritten to place Xi’s philosophy at its core, while making it the duty of CCP members to protect it and Xi, most China experts say there could be more terms to follow. This extension of power was also a centralisation. The Politburo and key positions were stacked with Xi supporters: ‘Ideology czar’ Wang Huning stepped up; former Shanghai boss Li Qiang  is the new Premier; ‘market-favourites’ Li Keqiang and Liu He stepped down. Moreover, despite the CCP’s media stewardship of its Congress, Xi’s predecessor Hu Jintao was forcibly ejected in front of cameras. The official excuse was that he was feeling ill: the CCP are aware the images struck many analysts as deliberate.

Bloomberg says, ‘Chinese Markets Tumble as Xi’s Tightening Grip Alarms Investors.’ Weren’t some there saying now was the time to buy just days ago? Won’t they be doing so again in hours?

China data were just released after a Congress-driven lag, and they were much better than expected: was someone busy the last few days? Growth was 3.9% q-o-q vs. 2.8% foreseen, and in y-o-y 3.9% vs. 3.3%, though year-to-date (ytd) still 3.0% as projected, suggesting backwards revisions. Elsewhere, industrial production was 6.3% y-o-y ytd vs. 4.8% expected even as local and global demand withers; retail sales were 0.7% y-o-y ytd, less than consensus; fixed asset investment was 5.9% y-o-y ytd vs. 6.0% expected; property investment was -8.0% y-o-y ytd, worse than the -7.5% expected; new home prices fell -0.3% m-o-m; and residential property sales -28.6% y-o-y, slightly better than -30.3% last month. I am not sure how much sense the GDP headline makes in the total context, or how much time we should spend worrying about it going forwards.

The balance of data show a litany of problems depressingly familiar to the West: too much private debt – Chinese consumers run higher debt-to-income ratios than Americans; too much public debt – local government revenue to expenditure ratios are just over 50%, and consolidated public sector deficits already sit at war-time levels; over-priced, over-supplied housing markets; massive income and wealth inequality; structural deflation – as the West had until 2021; a demographic collapse – the Chinese population could be close to that of the US by 2100; declining global demand for all goods, including Chinese (as export growth just slipped to 5.7% y-o-y while import growth stayed at 0.3%), as the US has clearly shifted demand to other producers since the Trump; and a Cold War, where the US is deliberately blocking access to technology.

How do you think China will resolve these structural problems? To clarify for IYIs, how will it resolve them in line with Marxist-Leninist-Maoist-Xi Jinping Thought? Does it mean more cheap stuff for the West, low inflation, and free hugs? Sadly, the potential disruption to such Western “because markets” analysis is enormous.

To put this in context, a recent global public opinion survey already showed pro-China sentiment collapsing in many nations while positive opinion of US has rebounded. The Financial Times carries an op-ed from former Australian PM and China-dove-turned-hawk Rudd, who even before the final Politburo line-up was clear and the Hu incident was arguing, ‘Xi’s congress report lays bare an aggressive and statist worldview’.

Businesses are not unresponsive – but naturally conflicted.

The Asia Nikkei says ‘Japanese companies explore how to go ‘zero-China’ amid tensions’, and claims Honda has been pursuing a plan to cut China from its supply-chain – and finding out this is going to be fiendishly expensive/inflationary.

Germany’s Chancellor Scholz, busily backsliding on pledges to rearm “because inflation” (to paraphrase Blair, “If you think defence is expensive, try a lack of it.”), is insisting trade with China must continue, and China can buy a stake in Hamburg port despite the idea being shot down by all other stakeholders. Then again, as Eastern Europeans currently quip, Germany is a trade association pretending to be a state.

Perhaps summarizing the United States’ view, The Hill runs a pull-no-punches op-ed by a former China writer for The Economist Intelligence Unit titled, ‘Ten years ago, we got Xi Jinping wrong. On his coronation, we should reflect on why.’ It opens that pro-China Western experts “to a man, […] got it wrong.” It underlines, “In my time in China, I have met some fascinating characters who are essentially selling out American interests but are completely oblivious to their own role, or the collective role of the business community.” It concludes, ”People in my network express alarm that just as they are waking up to the threat from Xi’s China, they are becoming increasingly powerless to effect change within their own organizations. Perhaps this sensational week in Beijing will help to reverse that trend. But I wouldn’t bet on it.”

Not betting on business as usual is historian Niall Ferguson, who has a doughty op-ed on Bloomberg, and a doughtier academic paper to back it up, which underline to IYIs why this matters. It is titled, ‘How Cold War II Could Turn Into World War III: History shows that nothing causes fiscal and monetary instability quite like multiple big, long conflicts.’ The key points are:

“Great conflicts were the dominant phenomena of the 20th century, transforming economic, social and political life almost everywhere. But in recent times, their importance has somewhat faded in most minds. It would not be too much to say that during the interwar era of 1991 to 2018 –in other words, the period between Cold War I and Cold War II– many economists and policymakers lost interest in war.

Because the wars of the interwar era were relatively small (Bosnia, Afghanistan, Iraq), more closely resembling colonial policing operations, we forgot that war is history’s most consistent driver of inflation, debt defaults – even famines. Large-scale war is simultaneously destructive of productive capacity, disruptive of trade, and destabilizing of fiscal and monetary policies. Economists tend to treat wars as “exogenous shocks,” generally omitting them from their models. From the historian’s standpoint, however, war is not exogenous, but the endogenous prime mover of the historical process – “the father of all things,” as Heraclitus said.

First, wars have played a very noticeable role in the history of inflation expectations… Second, wars have often been responsible for discontinuities in the history of interest rates.”

Ferguson underlines Covid engendered both war-scale fiscal responses and a war-style shut down of productive capacity: and here we are today; and war is still with us.

“It goes without saying that the return of great-power conflict has made the life of policymakers difficult, just as it did in 1973. I recently heard it said that the 2020s are not likely to be as inflationary as the 1970s because labour is less organized, so the risk of a wage-price spiral is lower. But I would draw your attention to a number of important differences that make our contemporary circumstances more worrisome than the situation in the 1970s.”

In short, money-supply growth is higher; productivity is worse; demographics are worse – more elderly people means higher inflation, not higher asset prices “because retirees”; fiscal positions are far worse; financial markets are more fragile; so is the environment.

Ferguson concludes:

“We may get lucky. We may get away with just re-running the 1970s – though judging by recent events in the UK, we may do it at a rather higher speed: from the inflationary Barber budget (1972) to the Winter of Discontent (1978-9) in a matter of weeks rather than years. Yet there is a much worse scenario, in which we get something closer to the 1940s, with regional conflicts coalescing into something like World War III – albeit with smaller armies, many unmanned weapons systems, and far more powerful and accurate bombs.”

He decries both the US National Security Strategy and China. He worries that if we pursue Cold War II, we risk stumbling into World War III. Yet he does not suggest any off-ramp from the ramping up now evident on both sides.

Meanwhile, IYIs talk about Moron Risk Premiums, not the bigger picture risks that they “don’t do”.

Indeed, neoliberalism is so deeply entrenched in some minds that Adam Tooze shares the argument from the Centre for Economic Policy Research that Ukraine, in a total war against Russia, should embrace radical economic reforms that wither the size of its state to improve its fighting efficiency, rather than continue with the statist (Western-backed) mechanisms every economy has used throughout history. Ukrainians might suggest those authors try the front lines and see how they feel about the superiority of free markets vs. centralized authority.