«But in the meantime the locomotive runs, runs, runs / And the steam hisses and it almost seems like a living thing». She doesn't run anymore. L'Chinese economy – for many years now the largest in the world – no longer runs. In Francesco Guccini's cult song, the locomotive ends badly, and we certainly don't wish it on China. But the times when we used to say: "Luckily there is China" are certainly gone. Thank goodness because, however rusty the other carriages of the world economy might be, China, with its tonnage and its growth, would have guaranteed a constant boost to the planet's economy.
The real indicators
After the initial successes in the fight against the coronavirus – due to draconian containment measures and a spontaneous acquiescence of the Chinese, respectful of authority – there was little attention to prevention. Even if the percentage of fully vaccinated inhabitants compares well with those of advanced countries, China has staked everything on Made in China vaccines, which are less effective than the others.
When the Omicron variant – highly contagious – also arrived in the Celestial Empire, the outbreaks multiplied. The authorities reacted with the usual ruthless efficiency and the 'Covid zero' mantra has overflowed, due to closures and restrictions, in the 'zero growth'. Now the outbreaks appear to have been tamed, but the authorities are determined to prevent further flare-ups of infections and prudence sometimes verges on paranoia: in a Chinese city on the border with North Korea, residents were advised to close the windows to prevent nearby, on the wings of the wind, may the virus arrive.
Meanwhile, according to the 'law of unintended consequences', the lockdowns have indeed produced consequences. Foreign customers who counted on the efficient just in time of Chinese suppliers have decided to diversify their orders and move them to other Southeast Asian countries. These other countries have an advantage of cost of labor compared to Chinese manufacturers, but this competitive advantage had not been fully exploited, as China enjoyed a well-established reputation for quality and punctuality. But, now that many Western customers (including the 'honorary Western' Japanese) have ventured to other Asian suppliers, the loss of business is likely to be permanent. In short, it is unlikely that China will be able to return to past growth rates and we can no longer count on that locomotive.
Given the crayfish trend in late winter and early spring, it should now be taken into account that China's growth target of 5,5% for 2022 will be missed. OECD forecasts, released on June 8, put it at 4,2%, which is equivalent to saying that China alone is directly responsible for nearly a third of this year's lower growth. Moreover, the OECD forecast is based on a strong rebound from the summer onwards, thanks to reopenings and monetary stimuli. However, compared to the past there are structural conditions which make the Chinese locomotive less responsive to stimuli, starting with construction boom, to continue with the short leash on the gray cat (to recall a famous metaphor by Deng Xiaoping) of the animal spirit entrepreneurial, in order to avoid incurable fractures of social inequality, and for the friendshoring (Janet Yellen coined the neologism) which pushes to diversify investments towards countries friendlier than China.
It is true that, in an anti-inflationary key, Joe Biden has leaned in favor of lowering tariffs antidumping Chinese: but by now the Chinese themselves had practiced the trade diversion towards neighboring countries not affected by the trap of American protectionism. The only consolation is that, with the ever greater regionalization of trade, the world is a little less synodependent for growth and, with the moonshine in commodity prices, the country's downshifting of the long march eases already unsustainable tensions in commodities.
China will increasingly have to rely on internal question (its famous surplus in external accounts is shrinking towards 1% of GDP), but the confidence of consumers, burnt by the restrictions, risks leading to prudence in spending. Sure, in an other-directed economy, the authorities still have ammunition in the magazine, but it's hard to escape the impression that 2022 is poised to be a watershed year in China's unstoppable economic growth.
Of course, the Chinese events are part of the already sufficiently moved mosaic of the global economy. Where the weapons of economic policy are less effective in countering the economic consequences of the military weapons unleashed in Putin's war on Ukraine. A little bit of budgetary policy, to redistribute the repercussions of the cost of energy (incorrectly speaking of extra-profits, in reality they are oligopolistic extra-revenues), has been implemented in various ways in the various countries, but the inevitable running out of the measures dictated by the Covid emergency causes fiscal policy to normalize.
Normally we would talk about tightening by looking at the decline in structural deficits, which the IMF estimates amount to 1,5 points of GDP this year and next for the major advanced countries combined, but in reality it is the replacement of unearned income (public transfers) with earned income with the sweat of the brow and entrepreneurial risk as economic activity normalizes. On the other hand, if we look at the policies of public investment and facilitation of the various transitions (energy, ecological, digital), the public budget remains supportive of the economies. It was before the war, though.
While the monetary policies they must get out of the Covid emergency quickly, to nip the inflation hotbeds that have rekindled (finally!) almost everywhere. If they didn't, they would postpone, making it more onerous, the acknowledgment that the expensive-raw materials it made us poorer.
On the other hand, the most recent economic indicators show that, excluding China, the world economy continues to enjoy good health. The manufacturing component of the PMI is solidly above 50 (threshold that discriminates between expansion and contraction).
Orders increase and delivery queues lengthen, so that even if, damn it, the increase in demand stops, production will have to continue to grow to work off the backlog.
On the other hand, the job market on both sides of the Atlantic it still belongs to the seller, because there are fewer people looking for a job than there are vacancies. It then becomes difficult not to grant wage increases, so that the payroll (=hours workedXhourly wages) rises and fuels household spending. Which are drawing on the accumulation of savings (three-four thousand billion euros between the USA and Europe) forfeited when leaving the house was forbidden or very imprudent and travel was an obstacle course.
Those treasures are deducted from the inflation tax, no longer hidden as it used to be: just listen to the screams and clamors even on the staid BBC about the tragic dilemma between heat, heating, e eat, food, which many people are faced with. And albeit with some delay, also due to the mad desire to go on vacation which he renounced for two years, he will still have to deal with bills and receipts from supermarkets. The moment of redde rationem it will arrive after the northern summer.
Will inflation stay high?
A year ago these days the annual price increase it was starting to accelerate in substantial monthly increments. And we, like many others, believed that this acceleration was destined to prove temporary, because it was distorted upwards by many factors that could not be lasting. Then came the war in Europe.
It would be dishonest to say that the error of evaluation committed then and now to be attributed to the insane desire to lead the hands that has seized Putin. The rise in the cost of energy was earlier, and there short blanket of the labor market in the USA and in many other countries (Italian hoteliers have rushed to Poland to try to recruit waiters) had already begun to manifest itself twelve months ago.
Now there is a risk of make the opposite mistake, i.e. think that high inflation will stay for long? It depends on what you mean by high. The annual comparison ensures that the trend change of consumer prices tends to drop. Bad monthly dynamics won't slow down anytime soon, because they have accumulated in the production chains also delays in price increasesas well as deliveries.
Just read the PMI reports of S&P Global to understand that companies have many good reasons to adjust the price lists: raw materials, transport costs, expensive energy and the increase in labor costs. The latter is cited not only in the USA, but also in Europe, where the labor market is not as tight as across the Atlantic, judging by the unemployment rate.
By aggregating the component of prices paid and charged in services, i.e. in two-thirds of the economy (even more if only the private part is taken), it emerges that the monthly increases in price lists remain records or close to records. So we will have to wait a little longer before the price temperature drops significantly.
This additional delay in descent has implications for wage claims. And the spiral performs a further twist: "Another turn, another run", as they shouted in the amusement parks of the past to invite the villagers to go up again.
PS: to test our foresight, the analysis was written before the release of the US consumer prices on Friday June 10. Prices that turned out to be even more "burning" than consensus expectations, but not particularly surprising for us. Let me be clear: we are not in the presence of a further acceleration and the peak is likely to be close, if not exceeded, but the increases are too widespread, as demonstrated by the index of gnarly prices (sticky-prices) developed by the Atlanta FED, so that we can sleep peacefully on the monetary, and therefore financial, front.
The situation of interest rates and currencies
There are now more than 50 central banks which, in recent months, have raised rates, at least once, by 50 basis points. There direction of monetary policy has changed sign (except in China, a country which, as mentioned above, has other problems…), and, in addition to having changed its sign, it has also changed in intensity: the half a point seems to be the 'new normal', after testing the waters with quarter-point increments.
As already mentioned in the past, market rates did not wait for the increases decided by central bankers to respond to facts and intentions (guidance) of the monetary authorities. The rates on thirty-year mortgages in America they have well exceeded 5% (they have increased more than double the Fed's key rate increase since the beginning of the year), but, given that the Fed is determined to slow down the economy, the key rate hikes will continue. Mortgage rate hikes are helpful in cooling down residential investment, but a firm looking to fund 90-day inventories can still borrow money market funds at 1,5%, which, with much higher inflation (so that the value of working capital increases faster than the amount borrowed), is something the Fed will want to discourage.
On the other side of the Atlantic, rates follow the same trajectories. THE German savers will be happy to no longer have to be extorted by negative nominal rates, but they are not at all happy to see that at a rate that is finally positive (but not too much: 1,5% on ten-year Bunds) accompanies inflation above 8%.
Italy it has inflation that is not very different, but a rate higher by more than two points, with less punishment for savers but more punishment for those who have to service their debts (first and foremost, the State, i.e. us taxpayers, present and future). The spread result - by 225 basis points – increases, as mentioned in the past, because in times of rising interest rates the markets penalize those with more debt. But you don't have to worry too much of another installment in the horror saga of sovereign debt crisis. Both because i fundamentals today are solid: unlike 2011/12, the Italian current balance is in surplus, Italy is a country that produces more than it consumes and the net international investment position is largely positive; both because the ECB hints that it will not allow spreads to widen unless justified by the fundamentals themselves. Even after the cessation of securities purchases the reinvestment of those maturing will continue (at least throughout 2024)., and there's a useful flexibility here in the sense that a front loading of reinvestments if the markets were to attack vulnerable countries (the ECB statement speaks of Greece, but thinks of Italy…).
How long will rates be rising? Maybe less than you think, given that economies are already slowing down on their own, between the shocks of inflation which affects purchasing power and confidence undermined by war events. And this slowdown will also cool inflation. Central Banks want rates to go to 'normal' levels, though the normality', between threats of 'secular stagnation' and 'conjunctural stagnation', it is no longer what it used to be. It must be remembered, however, that in 1994, when there was the last soft landingpotential US growth was estimated at around 3% (today it is 2%), inflation core it was close to 3% (now 6%) and long rates were 7%, against the current 3,14%! There is still a wide sea between where we are now and where we were then.
The activism of Fed, which also starts one reduction of its active gargantuan (by not renewing the titles that come to maturity), comfort the dollar, which remains strong towards all, and especially towards the yen, which fell to its lowest level in twenty years. Who knows if this is the right time to bring prices in Japan out of the shallows of deflation… Lo yuan, which in the two years from the beginning of the pandemic to early 2022 had appreciated by 10% against the dollar, abruptly changed course and left 6% on the ground following the closures in Shanghai and its surroundings.
I stock markets they suffer but not too much, and two different judgments are possible on this relative stability. The first says that they resemble the orchestra that played serenely on the deck of the Titanic. The second judgement, mindful of the havoc that was predicted at the beginning of the pandemic (and which did not materialize, on the contrary...) sees the glass as half full and trusts, at worst, in the support of economic policies. At this moment the unknowns – first of all the results of the war in Ukraine – are too many to choose between these two judgments. But in any case, those who are intimidated can go towards defensive portfolio compositions. Or, go on vacation and trust that in the long run the shares - we have repeated it several times - remain the most defensive tool there is.
Moving on to alternative investments, what about cryptocurrency? The latest greedy havoc concerns one stablecoin, Earth, connected to a Moon, and intended to hold a stable bond with the dollar, through complicated algorithms that we did not understand and do not want to understand. What we'd like to understand is why there are so many consenting adults around who play around with thousands of cryptocurrencies whose intrinsic value is zero point zero periodic.
