“Once Again The Apparently Unthinkable Becomes The Inevitable”

By Michael Every of Rabobank

Prepare To Be Buffetted

Today’s Daily is not about Warren Buffet but geopolitics’ impact on markets, analogized with a buffet.

Dig into this: the G7 took us a step towards decoupling: they say “de-risking”, but it’s same thing. This is ‘not about keeping China down, but lifting the Global South up’ by diversifying strategic imports and exports. But: (i) who can say what’s a strategic when little things can be – for want of a nail, as they say; (ii) friendshoring will still find China supplying key inputs to other EM, and the impetus will be to move the whole supply chain, upstream to downstream; and (iii) diversification means zero-sum math – import more from one country, you import less from others, ceteris paribus, and export less to one country, you export more to others. Yes, the G7 can friendshore and China still be better off… but only if it shifts to consumption, services, and imports rather than production, manufacturing, and exports. Which it won’t/can’t.

If Chinese consumers had a CNY every time they were told they will drive growth, they would be driving it. Yet Xi says China’s focus is on supply chains and key industries, not real estate, services, and finance; and those “lying flat” must get married and/or go to the countryside. That economic model means investment/exports >consumption/imports, and it can’t be a win-win – it’s mercantilism. It’s like tourists at a hotel buffet who only take plates of shrimp, no carbs, soup, or veggies, and the restaurant owner isn’t allowed to go to a Chinese hotel and reciprocate at their buffet. As a result, we rapidly end up with different restaurants for different clientele.

Yes, China’s development model was previously used by the West, who gorged at the global buffet before being into DEI – while still not sharing any shrimp, or vaccines. But history shows that system always ends up in a food-fight, literally. It doesn’t matter if President Biden wants to dial back (“Biden Sees Coming Thaw with China, Even as He Rallies Allies Against Beijing”): the mercantilist dynamic won’t allow it. If the US says, “Beat you to the shrimp!” and China that “the international community does not and will not accept the G7-dominated Western rules that seek to divide the world based on ideologies and values,” while calling UK PM Sunak a “US eunuch”, things only get nastier.

Yes, a Bloomberg op-ed from Niall Ferguson argues the US should use détente to buy time to rearm and reshore. Yet if China knows the US needs time, why not act? Note that it banned Micron from the US for security reasons just after Biden’s olive branch. Expect more of that when China’s Commerce minister meets USTR Tai this week, who will say, “People who only take shrimp have shellfish habits.”

“It’s not rational for China to escalate,” say voices shocked at The Wall Street Journal noting “China’s Xi Mimics Mao’s Crisis Response in Sweeping Indoctrination Drive” and the Guardian saying, “China crackdown on business has Maoist roots.” The same article quotes a professor of Chinese management at Cambridge University saying the recent crackdown on consultants, etc., lies in CCP ideology, and one must “dig into the Maoist roots in Chinese institutions and political economy to try to understand ideas that Xi has””. That’s what I wrote in 2021’s ‘Pro-Fund or Profound Revolution?’. The CEOs and Wall Street asset managers who still don’t do so have perhaps eaten so much shrimp they now think like one.

And China can escalate in lots of different ways.

Ironically, it could even buffet the US ahead with big fiscal stimulus for its stale economy, boosting Western commodity inflation on top of that from its re/friend-shoring into the 2024 election. Who knows if that is on the menu ahead, but Beijing is trying to cook up imported commodities paid in CNY via PBOC swaps, which would give it more room to do so. Yes, CNY would likely slump on the extra policy loosening –which would also be an attempt to push out more exports– and US tariffs, and rates, would rise in tandem. The Fed’s Bullard and Kashkari will both back that move for sure, seeing as one talked of two more rate hikes this year yesterday, and the other that a June pause shouldn’t mean an end to policy tightening. Daly was more cautious, as was Bostic, while Barkin is on the fence.

We can also expect crabby moves from the US Congress, which is not pro détente.  Recent testimony there from former USTR Lighthizer shows how sentiment has shifted on Capitol Hill: “Since 2001, we have directly transferred more than $6 trillion to China through our annual trade deficits…During the Cold War with the Soviet Union, it would have been inconceivable for the US to allow such a massive wealth transfer to happen,” from the guy supposed to be pro trade, and, even more bluntly, “When I’ve talked to someone who doesn’t believe they’re such a serious threat I’m always like, ‘Oh, you must have some investments over there – I get it.” US CEOs or asset managers with China investments must be shifting uncomfortably in their seats, and not just because the Shanghai stock exchange has only returned 4% over the last five years of ‘buy now!’ sell-side notes: indeed, they fear ‘The China Hawk in Washington Rattling Corporate Boardrooms’.

Of course, it hardly needs saying that the US and G7 are not up for détente with Russia. National Security Advisor Sullivan just stated it’s okay for Ukraine to use Western missiles to attack Crimea, because that’s not part of Russia, and President Biden signed off on F-16s for Kyiv: once again the apparently unthinkable becomes the inevitable, and at scale given the number of F-16s available. Note that as Australia is experimenting with a 4-day week(!), Russia may go to 6!

So, the unsavory dish today is the warning not to buy geopolitical ‘risk-on’ fairy tales. The inedible item left at the far end of buffet, to be recycled into a pasta bake by Friday, is that this matters for inflation and rates to the upside, or a lack of downside.

Help yourself, if so.

And now, for those who think politics doesn’t impact on markets, back to the drama of the US debt ceiling – which also makes my point. As does that Warren Buffet sold his shares in Taiwan’s TSMC on perceived fat geopolitical tail risks; The Times alleges national politics influenced LIBOR lower; and it is again made clear that the Pentagon was watching SVB all the way.