The Coming Winter of Discontent

Freedom Financial Archive | Originally posted Nov 30, 2022
  • The economic data deteriorates with every new release.
  • Global trade is starting to feel the cold.
  • China’s misguided zero covid policy sends problems back up the supply chain to emerging markets.

(Good) News Is Bad News

All of the economic data that has come out in October and November show a global economy weakening rapidly.

The global trade index fell to new cyclical lows (down 6.4% year-on-year), which should soon be reflected in global exports.

They have recently been supported by emerging markets, but we see a lot of downside to trade in the emerging market (EM) regions from year end and well into 2023.

This will put more pressure on underlying crude demand as refined products struggle to find buyers.

The global economic slowdown is coming in with a lot of weak data from China and other global demand centers.

Demand has dropped off in China and North America, and I don’t see any near-term recoveries in those regions.

China’s Syndrome

At the moment, the zero-COVID policy isn’t going anywhere with a lot of regions doubling down on the enforcement even after protests hit a lot of locations throughout China.

The wave of public protests this weekend against China’s strict pandemic controls forced authorities nationwide to respond on Sunday and Monday.

According to Trivium, the zero-COVID policy isn’t going anywhere:

Instead, Beijing is doubling downCentral authorities have told local officials they must strictly follow the zero-COVID playbook by implementing the recent 20 policy tweaks aimed at “optimizing” COVID controls and minimizing disruption to people and businesses.

The central government’s response came in multiple editorials in Party-state media, calling for more precise COVID restrictions, support for those affected – and adherence to the zero-COVID policy.

City authorities reiterated the rules that local officials must follow, including:

  • The Beijing government stressed the ban on using chains and other physical barriers to enforce lockdowns that increase the risk of fatalities in case of fire or other emergencies.
  • Several local governments pledged to keep hospitals accessible for non-COVID patients.
  • Guangzhou announced that communities without new positive cases for five consecutive days can request reopening, and certain groups are exempt from frequent COVID testing.
  • Hefei released a list of 16 prohibited measures, including hard barricades to enforce lockdowns.

Most restrictions will remain in place. The protests ramp up pressure on local governments to implement more strictly Beijing’s (now more restrained) zero-COVID playbook.

That’s because the fundamental fact remains that if tight controls were abandoned, China’s hospital capacity would be overwhelmed.

Then the likely death rate would be higher than leaders in Beijing could stomach.

Get smarter: Increasingly widespread non-compliance with zero-COVID measures will increase case counts to levels that demand prolonged lockdowns. But harsh citywide lockdowns have grown a lot harder to enforce.

Get ready: Our bet is the government will lock down hard again, stamping out online and in-person protests, if COVID continues to run wild.

At the moment, the government is stuck trying to enforce their rules.

But as Omicron and other more virulent strains become dominant, COVID will spread more quickly complicating the policies.

Even though this is creating a problem now, it could pose an opportunity this coming March or April for an accelerated reopening. But that won’t be even hinted at until next year.

China is facing a huge surge in youth unemployment and further unrest is likely to follow.

China announced Q3’22 growth of 3% (which is already suspect) but makes the ability to hit the government’s target of 5.5% for the year impossible.

Income gains have suffered. Increases in real household income slowed to 3.2% year on year over the first three quarters of 2022, less than half the average pace of 6.7% in the five years before the pandemic. Meanwhile, savings rates are climbing again this year – a sign of economic anxiety that depresses consumer spending and growth.

The local governments have had to bear the brunt of the widening deficits.

As economic activity slumps further, the regional CCP players will have to pick up more of the pieces to fill the gap.

Since their main source of income was real estate and taxes, things will continue to get worse.

And since everything is backed by the CCP and PBoC, stress is only going to grow throughout the region.

Lockdowns have dragged down local tax revenues and driven up government expenses. All 31 of China’s provinces ran deficits in their general budgets in 1H, with some 23 provinces recording deficits that were bigger than their full-year shortfalls in 2021, when measured as a percent of GDP. The longer strict containment measures stay in place, the worse the situation will become.

The PBoC cut reserve requirements to 11% from 11.25%.

But there is already no demand for leverage, so it won’t prompt additional credit.

Instead, industrial profits are dropping faster than expected. That hinders the willingness of companies to borrow additional funds.

If your income is falling or less stable, why pick up more interest expense?

Upstream and Downstream Under Pressure

  • Profits weakened in upstream and downstream industries.
  • Among upstream industries, profit growth of mining industries slowed to 60% in the 10-month period from 76% in the first nine months of 2022.
  • Looking downstream, manufacturing industries’ profits dropped 13.4%. That’s slightly more than a 13.2% fall in the first nine months.
  • By ownership, profit growth of state-owned enterprises slowed to 1.1% from 3.8% in the first nine months. The private sector remained deep in the red, with profits of private enterprises falling 8.1%, the same pace as in the nine-month period to September.

The deterioration is accelerating in China and the OECD nations, which is reverberating back up the supply chain into emerging markets.

The global economy faces a big problem that the markets still haven’t wanted to face: a global recession and central banks still raising rates… or at least not cutting.

The Fed just reiterated again their likelihood of raising rates again and keeping them higher for longer.

We’re still a long way away from relief coming to the market by way of stimulus.

Until next time.

Best regards,

Freedom Financial News