Macro Hive Weekly Brief: China Silver Lining / Fake Recession / Oil Bounce
(total reading time: 10 mins)
I doubt the Fed predicted the market carnage following its ‘hawkish’ cut last week. US bond yields plunged by over 35bps – the largest drop since 2011 when the Euro-area crisis was erupting – and equities fell over 5%. The dollar also rallied, notably against the Chinese renminbi which broke the 7 level. Admittedly it wasn’t just the Fed that triggered these moves. The escalation of the US-China trade war also contributed. Moreover, illiquid markets probably exacerbated the moves, something we covered in one of our specials last week.
It’s tempting to paint an apocalyptic picture when looking ahead, but we present three special reports with a more sanguine take. Morgan Stanley’s excellent Asia strategist Mirza Baig argues that the escalation of the trade war and CNY weakness may end up being positive for EM high-yielders – especially if it leads to more Fed cuts. Independent oil analyst Virendra Chauhan writes that the market is under-appreciating coming oil supply cuts, which will support oil prices. And veteran market strategist John Tierney proposes that typical business cycle indicators can no longer predict recessions.
Elsewhere in our curation of blogs, we find some – including Blackrock – calling for the ECB to start buying equities. Seasoned China watcher Michael Pettis makes the case for taxing capital inflows, and we also have a brief on Apple’s upcoming foray into credit cards. We also feature a breakdown of the costs to US households of the tariffs on Chinese imports.
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Renminbi Falls. But could this be good news?(2 min read) The recent drop in CNY is categorically different from last year’s plunge. This time the tariff’s will bite the US consumer due to its wider coverage, the Fed will likely ease rather than hike, and it lowers the chances of a disorderly devaluation. In the end, the easing Fed will likely boost EM high yielders. (August 8│Mirza Baig)
Oil’s existential crisis? (3 min read) The recent plunge in oil will likely prove temporary. The US-China trade war and slower global growth will certainly hit oil demand, but oil supply losses are being overlooked. In the near-term oil will likely return to its $60-$70 range, but could eventually move to $80. (August 6│Virendra Chauhan)
Recent Recession Forecasts are Crying Wolf (4 min read) Calls for recessions have been proliferating. Many are based on a standard reading of business cycle indicators. Yet recessions in recent decades have been caused by crises rather than the typical tight monetary policy and overheating economy dynamic. This suggests identifying crises will be key for the next recession. (August 8│John Tierney)
Central Bank Equity Purchases: An Idea Whose Time has Come (Roger Farmer’s Economic Window, 2 min read) Recently in the FT Rick Rieder, a BlackRock executive, called for the ECB to begin purchasing equities as part of its QE program, sparking new debates around the invasiveness of Central Banks. He was accused outright of a conflict of interest, though, because he’d probably benefit from the idea. Others point out that such equity purchases distort price signals and the ‘invisible hand’, and won’t do much to fix the structural issues at play in the Eurozone. In this blog piece, Roger Farmer offers some support for Rieder. He argues that while asset markets do well at allocating capital across industries, they are inefficient when it comes to allocating it across time. Plenty of theoretical and empirical research documents the usefulness of a policy tool that controls the share prices of a European index fund. Farmer suggests it as a complement to the conventional interest rate tweaks.
Why does this matter? So far, much of the debate around ECB policy has revolved around further QE or deeper rate cuts into negative territory, but it could make sense to try something different like buying equities. Moreover, the BoJ has already done it and it could also boost efforts to create a capital union in the EU.
Is the Fed Doing Anything Right? (New Monetarist Economics by Stephen Williamson, 5 min read) Stephen Williamson, from the University of Western Ontario, dissects the Fed’s explanations for their interest rate cut. He finds them all insufficient. The labour market is holding up to last year’s records when it was tighter than it had ever been (as measured by the ratio of job openings to the number of unemployed). Similar to global trends, Home GDP growth has been smooth in the past 10 years, with unemployment rates consistently falling in Japan, the Eurozone, and the UK. Chair Powell’s claims about lower investment levels aren’t supported by the data either. Williamson then moves on to inflation, which he does agree is below target, at 1.6%, and if one believes in the Philips Curve (he doesn’t), the rate cut seems logical. However, he shows that the curve is currently flat and with the labor market capacity already stretched, inflation won’t see much of an impact.
Why does this matter? Williamson joins a large number of people struggling to justify the Fed’s move. The world won’t end, but Powell might have lost the reputation he enjoyed in his early days as a Chair. Academics, in particular, are turning their eyes to the Japan experience, as we discussed last week, expecting inflation to remain below 2% long term despite lower rates.
The Great Inflation Delusion (Dr. Ed’s Blog, 4 min read) The deflation plaguing Western economies in recent years is much discussed. This piece by Ed Yardeni, a Wall Street veteran and Chief Economist, argues that Central Bankers are fighting for a lost cause because deflation is structurally driven by what he defines as the four D’s. Détente, which is a post-war period of competition and globalization that organically drives prices down; Disruption – accelerated technology advancement is highly deflationary, and there is plenty of incentive for it because it drives down costs; Debt – the crash of the 2008 credit bonanza was clearly a deflation contributor too, now disrupted by dovish monetary stances; and finally, Demographics - Yardeni blames the geriatric trend present. People are living longer and having fewer children, which accumulates more debt, which suppresses growth and is inherently deflationary.
Why does this matter? More and more researchers are claiming that Central Bankers are getting it all wrong (we shared Juliette Declercq’s criticism of them in this week’s podcast newsletter). Yardeni, similarly to Williamson in the analysis above, disagrees with the forced expansionary monetary policy. He claims that deflation might be much more of a microeconomic phenomenon. Or maybe deflation isn’t so bad after all or it’s possible that central bankers have run out of tools – or ideas.
Washington Should Tax Capital Inflows (Carnegie Endowment, 4 min read) Last month, a bill was submitted to the US Senate: the 'Competitive Dollar for Jobs & Prosperity Act'. It aims to maintain a current account balancing price for the dollar within five years. In this article, Michael Pettis, Professor of Finance at Peking University’s Guanghua School of Management, argues that taxing capital inflows might be the only effective way to tackle trade imbalances other than imposing tariffs. However, Pettis highlights that the big risk with taxing capital inflows comes when there are capital shortages in the US. Overall Pettis considers that the recently proposed bill is a step in the right direction to address trade imbalances.
Why does this matter? The US has a persistent trade deficit and lawmakers have always sought to address this by way of trade tariffs, which are considered a far inferior tool than taxing the capital inflows.
Everything You Need to Know About the Apple Card (Highsnobiety, 4 min read) Goldman Sachs and Apple are partnering to enter the consumer credit space, largely targeting millennials. At its core, the Apple Card is a simple to use, no fee credit card that also serves to educate its users on their financial health. It closely tracks spending and changes colours in your iphone wallet accordingly – going orange or red if you spend too much. A physical card is available, but there’s no number, security code, or expiration date, something Apple claims is more secure. One of the card's most distinctive features is ‘Daily Cash’, where users can redeem cashback. Highsnobiety gives a neat review of the card and why you should (or shouldn’t) get it.
Why does this matter? Apple claims that the new card is not meant to directly compete with premiums like the Chase Sapphire or American Express Platinum— the goal is to be broadly accessible to every iPhone owner, so the signup requirements are lenient and take less than a minute. Apple also promises that it doesn’t have access to spending data, which is only available to Goldman under strict privacy agreements. It hasn’t fully launched yet but in typical Apple style, the card has already created a buzz – 38% of US adults are aware of it and 35% are likely to apply.
U.S. breaking promises is setting new obstacles for trade talks with China (People’s Daily, 3 min read) China is clearly unhappy with the US breaking established trade agreements. Washington promised to impose no further tariffs on Chinese goods during their meeting in Osaka at the end of June, but a few days ago they reneged, slapping an additional 10% on $300bn worth of imports. This article, whilst clearly biased to favour Beijing, points out fairly that the decision was backward and disruptive for both sides and also globally. In fact, the US markets dropped because of it. The authors claim that such US behaviour will be detrimental to business confidence, hindering big-ticket investment for now.
Why does this matter? The US backtrack possibly triggered China’s currency devaluation as a way to soften the blow of the extra tariff. Following up on this, Charles Hankla, a political scientist from Georgia State University, doesn’t see an end of the war in sight. He writes that a trade war can only be won if one country has more bargaining leverage than its opponent. And he doesn’t believe that’s the case here.
New China Tariffs Increase Costs to U.S. Households (Liberty Street Economics, 4 min read) A recent NBER study found that the full impact of the China tariff falls on domestic consumers, with a reduction in US real income of $1.4 billion per month by the end of 2018. The cost is twofold: an added tax burden and an overall deadweight loss. This piece uses the study to predict the extra cost of the May 2019 increase in tariffs (from 10% to 25% on $200bn of Chinese imports). The tax proportion of the cost actually falls, as consumers are likely to switch to substitute countries for their purchases such as Vietnam. It’s unlikely that spending will be directed to home producers, since studies show that when one emerging country struggles, the others quickly pick up the extra demand. Deadweight loss, however, increases from $132 to $620 per household, tallying up the total cost to $831.
Why does this matter? Revealing the imminent cost to households makes all too real the impact of the trade war. Additional tariffs are clearly damaging given the huge efficiency loss and this should be part of Trump’s considerations, especially given his re-election ambitions.
The Real Reason for China’s Rise (Project Syndicate, 3 min read) Most outside observers assume that the Chinese growth engine is fuelled solely by an asset-endowed government pursuing policy that restricts freedom for the private sector. In this piece, Zhang Jun, Dean of the School of Economics at Fudan University, argues that over the past forty years American-style capitalism has found its way into the Chinese model, creating economic liberalization. This is most clearly evident in the tech sector, with giants like Alibaba, Tencent, and JD.com established as global leaders; even Huawei, which suffered direct attacks rose eleven places in the Fortune 500 last year.
Why does this matter? With the Chinese economy’s recent slowdown, Beijing needs to address the structural issues at play such as the rising cost of finance and declining return on capital. Most importantly, though, it needs to recognise what worked well: freeing up private entrepreneurship and fostering competition if the country hopes to maintain its accelerated growth amidst turbulent times.
The Messy Truth About Social Credit (Logic Magazine, 10 min read) Western media has a knack for portraying China’s social credit system as a sinister, invasive method of controlling society by assigning a behaviour score to each citizen. This carefully considered article argues, however, that while a score system does exist, it possesses a more benign purpose. It is set up to inject trust into the economic ecosystem, incentivising integrity and penalising lawbreakers by blacklisting them. You might end up on the list if you don’t pay debt as soon as extra cash is available, or if you don’t comply with a court order to visit your elderly parents. Beijing works closely with technology firms to gather this data, which is mutually beneficial because the blacklisted are less likely to be hired, lack access to private schools, and are banned from purchasing, say, luxury goods on Alipay. These collaborations go as far as creating ‘credit cities’ where citizens with good scores can rent flats without a deposit or delay cab ride payments. So is the system fair? And does it serve its purpose?
Why does this matter? Collecting and storing citizen data citizens is neither new nor unique to China. In the US, businesses and the government gather and use information from consumers ranging from shoplifting behaviour, bad rental and tenancy records, and return-shopper fraud. Even though it’s subtler and less threatening than in China, given the ease of access into personal lives that technology has enabled, activists are calling for more transparency and accountability.
Chinese universities need to attract more foreign students, but not by treating them differently (SCMP, 3 min read) Despite being a 'net exporter' of talent and also Asia's top destination for overseas studies, China struggles to attract top students from abroad (only 0.6% of students are international students in China, compared to 5.3% in the US). In this article, Wang Huiyao, founder of a Beijing based think tank, argues that with trade – the core engine of Chinese growth – weakening, global talent flows will hold potential to maintain development. The improvement and provision of more courses conducted in English and the better integration of foreign students into the educational and social structure are suggested as just some of the ways to tackle the dire situation.
Why does this matter? A few weeks ago we discussed the growing number of Chinese scholars based in the US. Now the tables are turning and China is waking up to the potential of international education to grow into a local, staple industry similar to the US and the UK – contributing jobs, revenue, and injecting innovation into the country. We believe that the timing is right, given the Belt and Road Initiative pending and the trade wars hindering an already slowing economy.
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