When last we checked in on Albert Edwards, SocGen’s incorrigible but exceedingly affable bear had just returned from the Amalfi Coast where he surveyed the ruined towns of Pompeii and Herculaneum.
Naturally, that prompted Albert to suggest that investors can probably learn something from “the cowering skeletal remains” he checked out while on vacation. Specifically, he postulated that in the event the Fed keeps tightening, equity longs might get “fried alive” Mount Vesuvius style.
Fast forward a couple of weeks and investors are probably feeling a bit like they’ve been showered in volcanic ash. This is on pace to be the worst month for U.S. stocks since the crisis days and the Nasdaq plunged the most since 2011 on Wednesday.
Well on Thursday, Albert is back and he’s tilting at a familiar windmill: China.
Needless to say, talk of a “hard landing” is making the rounds again (as it’s wont to do every couple of years), this time in the context of the trade war. Long story short, Donald Trump has thrown a monkey wrench into Beijing’s deleveraging efforts by making it virtually impossible for Chinese policymakers to tighten policy.
You can’t very well keep turning the screws on liquidity at a time when trade frictions are likely to worsen the economic deceleration, and indeed, China has resorted to easing on both the monetary and fiscal policy front over the last several months. That is a tightrope walk, though. Looser monetary policy means a widening policy divergence with the Fed, which in turn puts downward pressure on the yuan, raising the specter of capital flight. But perhaps more importantly, halting the deleveraging effort risks making the credit bubble worse.
With all of that in mind, Edwards asks whether China is “running out of luck.”
“China’s policymakers are regarded as having had a very good crisis in 2008 [and] since then, naysayers, such as myself, have been consistently wrong in projecting that policymakers would lose control and that a grotesque credit bubble would burst and lay the economy low”, Albert concedes, before saying the tide may be turning for the naysayers.
Essentially, Edwards argues that everyone is more worried about the possibility that China’s response to the trade war will catalyze a rout in global markets than they are about a hard landing, and that may be a mistake. To wit:
Once again fears are mounting about the Chinese economy slowing rapidly, but few fear a bust. Instead, as US President Trump exerts mounting pressure on the Chinese economy via tariffs, the worry is that a Chinese policy response will send the global markets into a tailspin, just as the August 2015 devaluation did. In that context, the recent swing into current account deficit makes Chinas policymakers job even harder.
Edwards, citing a colleague, notes that if the swing to a deficit proves to be permanent, “it will increase the fragility of the renminbi at a time when economic growth is slowing sharply.”
That’s true, but again, that’s in some ways more worrying for global investors than it is for China itself. After all, capital flight has seemingly remained muted amid the recent slide in the yuan, and assuming that remains the case, it’s possible that Beijing can just keep easing both on the monetary and fiscal policy front in order to combat the slowdown.
Or can they? Albert’s point – and again, he draws on the work of his colleague, China Economist Wei Yao – is that Chinese policymakers may be running out of luck. Recall what we said above about how Trump’s combative trade stance has complicated China’s efforts to deleverage. They can ease and they can conceivably control capital flight, but what they can’t do is ease aggressively without risking a further inflation of the credit bubble.
“After the aggressively expansive monetary and fiscal policy of 2015/16, the authorities remain determined not to reignite the credit bubble”, Edwards writes, on the way to observing that “the overall public sector deficit is already at 2009 crisis levels of 11% of GDP.”
“Chinese policy seems to swing from feast to famine as policymakers grapple with the increasing instability of the credit bubble they have created”, Albert warns.
The read-through, according to the above-mentioned Wei Yao, is that “Chinese policy easing in the face of the current sharp slowdown as only half-hearted.”
And that leads naturally to Albert’s conclusion, posed as a question:
But yet no one expects a hard-landing. Why not?