Are we in a “new paradigm” which involves inflation being a relic of the past?

Most likely not.

We are simply in a context where monetary base inflation did not lead to consumer price inflation but rather asset price inflation at best, with many economists making the mistake (in our view, at least) of viewing things through the lens of predictability and expecting linear developments. Just like a chef adds a little bit of seasoning until the taste is just perfect, it is expected that central banks will keep expanding the monetary base until “just the right amount” of inflation manifests itself.

In the opinion of the ChinaFund.com team, this perspective is nothing short of delusional. When referring to markets, expecting manic-depressive behavior rather than extreme predictability is always recommended, with pretty much any longer-term asset price chart representing an eloquent example to that effect.

To put it differently, while nobody can predict when we transition from a deflationary to an inflationary environment, we strongly believe the process will be anything but smooth and predictable. On the contrary, we expect “chaos” to be the operative word and for the now-unthinkable to occur: a significant loss of confidence in even the strongest Western currencies, including… of course, the dollar.

Where does that leave China and the renminbi?

Time and time again, we try to make it clear that just because China and the proverbial West are let’s say economic adversaries who are fighting for relevance and influence, it doesn’t mean that whenever the West loses, China wins, especially not as far as short-term perspectives are concerned. On the contrary, given the extreme economic interconnectedness which represents the norm in 2020 (despite a massive build-up of frustration, but that goes beyond the scope of this article), China is actually likely to not only catch the proverbial cold from the West but develop worse symptoms.

Let us not forget that the number one holder of dollar reserves is none other than… drum roll, please… China. As such, it would be short-sighted at best and naïve at worse to assume that China would be greedily rubbing its hands when the dollar loses value. On the contrary, the Chinese renminbi would most likely be in even worse shape at that point in time.

Why?

Simply because whether one analyst or another agrees with this, the United States still represents the world’s number one safe haven destination (the destination frightened investors flock toward during risk-off episodes), whereas China doesn’t even represent a safe haven destination at this point, with Chinese assets firmly in risk-on territory.

Yes, it is true that in just one year of post-Great-Recession easing, the Federal Reserve added more to the monetary base than had existed from 1913 up until the Great Recession. But it is just as true that since then, demand for US dollars has gone up rather than down. While it is correct that the euro has had a good run over the past couple of months, it is still considerably lower relative to its US counterpart than it was prior to the Great Recession.

Let’s just say that until the market grants China its much-desired safe haven status, it would be premature to state that China celebrates weakness in “competing” currencies and on the contrary, it is likely to be worried by them because unlike the Federal Reserve and the European Central Bank since the Great Recession, their Chinese counterpart (the PBOC) also has to worry about inflation every now and then. To put it differently, inflation is (even if not always and even if it isn’t exactly the norm) a CURRENT rather than potential PBOC concern and as such, it would be unwise to believe China is longing for a more inflationary environment.

Finally, there are also those who noticed that China has been adding gold reserves over the years and therefore believe it isn’t as worried about inflation when it comes to Western currencies as we have stated. But in terms of (and this is very important) orders of magnitude, China is nowhere near protected enough by its gold holdings to sleep tight at night while the West were to battle inflation, not by a long shot.

A few important conclusions therefore arise:

1. The demand for dollars should not be underestimated because no matter how aggressively the Federal Reserve eases, there will be no runaway inflation unless and until dollar demand takes a significant hit. Until now, that hasn’t happened but, of course, past performance does not guarantee future results
2. China is not yet considered a safe haven destination by the market and until that happens, not only would is it vulnerable should weakness manifest itself when it comes to Western currencies, the renminbi is also likely to fare considerably worse than the currencies in question
3. While there have been measures taken by China to distance itself from the dollar (from the previously mentioned gold reserves to negotiating renminbi oil deals and establishing renminbi ties to other economies), a fair case can be made that it is still considerably (over-)exposed to the dollar
4. However, conclusions #1 to #3 are not set in stone in terms of the (very) long-term picture and on the contrary, it is anything but impossible for game-changers to occur

1. The fact that China’s education system is still far from optimal, despite the fact that impressive progress has been made. In many regions of China, there are still issues with basic literacy and as such, expecting the average Chinese saver to properly understand today’s ultra-complex realities would be unrealistic. For more information about China’s education system and how it compares to various Western counterparts, we would recommend reading the article we have dedicated to this topic by clicking HERE
2. The fact that various dimensions of China’s financial system tend to have an above-average percentage involvement of so-called “retail” investors compared to professionals, with the Chinese stock market being a relevant example in that direction. Once again, we have dedicated an entire article to this topic, one which can be found HERE
3. The fact that the average Chinese citizen doesn’t exactly have as much access to let’s call it “less than curated” investment information. Say what you will about Western financial media outlets but compared to the information level of the average Chinese investor, Westerners seem light years ahead. While it is true that gaining access to the “real” Web by for example bypassing the Great Chinese Firewall is hardly impossible, it is fairly safe to assume that Chinese savers are at a disadvantage compared to their Western counterparts
4. The fact that from a cultural perspective, there is hardly anything in the way of tradition that has been reinforced historically speaking. To put it differently, older generations have been far too “busy” with subsistence to care all that much about being wise savers, with them hardly having enough wealth at their disposal for dedicating a lot of time to such endeavors to make sense

The list could continue indefinitely but the bottom line is this: Chinese savers can, at this point in time at least, be considered at a disadvantage compared to their Western counterparts. However, make no mistake, this most definitely does not mean that Western savers have it easy. On the contrary, as discussed in other articles as well, savers in general have been systematically punished all over the world due to “paradox of thrift” implications: simply put, the worldwide economic system needs perpetual debt-fueled consumerism to sustain itself and savers stand in the way. This, however, is a topic that goes beyond the scope of our article.

Suffice it to say that the current status quo revolves around governments and central banks from all over the world (with China not representing an exception) engaging in currency debasement one can consider unprecedented in terms of sheer contagion (to use a term more and more common in 2020). To put it differently, one cannot exactly seek refuge in Country B’s currency if Country A is in full-on debasement mode for the simple reason that the Country B’s of the world are engaging in precisely the same behavior. As such, even for sophisticated savers, protecting their purchasing power at the very least and especially enhancing their wealth becomes a problematic goal, with many of them feeling as if they have absolutely nowhere to hide.

Fortunately, this is not true. In fact, we have dedicated a fair number of article to explaining, from A to Z, what savers from all over the world can and should do to protect themselves, with many more articles on the way. Unfortunately, doing so is anything but easy and from the perspective of an unsophisticated Chinese saver who is looking for a “quick fix” solution, the entire equation seems unbelievably confusing.

The end result is therefore likely to involve an extremely large transfer of wealth from those who are not properly prepared/hedged to those who are. Historically speaking, the average citizen is usually on the losing end of such transfers of wealth and the less sophisticated they are, the more affected they are likely to be.

The implications of this reality should be more than obvious: the fact that the proverbial Chinese dream may end up being under siege. Long gone are the pre-2010 days of what seemed to be sustainable double-digit GDP growth, with straightforward international trade dynamics and much-needed domestic infrastructure spending. Fast-forward to the 2020 framework and we have even the Communist Party of China admitting that double-digit growth represents an unrealistic goal, major trade tensions between China and many trading partners that are so frustrated with the trade deficits their countries keep experiencing that they consider China the spoiled child of globalization and infrastructure-driven growth which can only take you so far… an amazingly complicated equation.

To state that the average Chinese saver feels overwhelmed would be a severe understatement and if history is to be any indicator, more or less obvious forms of civil unrest become pretty much unavoidable. As it was, many citizens were frustrated with the various inequality problems that sprung up in the aftermath of China’s economic growth story and while more recent administrations such as the Hu Jintao and nowadays Xi Jinping ones have done more than past administrations to tackle this issue, it becomes abundantly clear that innovative solutions are required in order to preserve the “socialism with Chinese characteristics” status quo. Because, make no mistake, a hefty price will need to be paid if the average Chinese saver becomes discontent with the status quo in a manner that leads to frustrations piling up, one the current Chinese administration can most likely not afford, especially given the “tricky” international context that dominates public discourse pretty much all over the world.

In other words, that the worldwide economic system can continue in a “business as usual” manner after the previously mentioned COVID-19 episode, with the average individual simply pressing the proverbial reset button and resuming the same consumerist pattern he has become (in)famous for. Furthermore, investors tend to strengthen this argument by also referencing the unprecedented levels of monetary as well as fiscal stimulus that have been embraced in China as well as pretty much everywhere else in the world.

Unfortunately, this perspective tends to be quite short-sighted.

Why?

Simply because unlike with the Great Recession, the 2020 situation has made it crystal-clear that no, money cannot fix absolutely everything. A textbook example to this effect was represented by the fact that some of the world’s richest nations on a per capita basis (the United States, Italy and especially the wealthy Northern Italian region, France and so on) found themselves in an unprecedented situation (in modern-day terms, at least) when tackling or better stated trying to tackle the COVID-19 threat: realizing that they have a lot of money to deploy but not nearly enough in the way of supply when it comes to much-needed medical equipment.

As such, the much poorer (on a per capita basis) China was able to implement containment measures far better than the previously mentioned wealthy nations for the simple reason that it is a major producer of medical equipment. In stark contrast, other countries found themselves realizing just how overly dependent on China they are and precisely when medical supplies were most needed, China was facing major bottleneck issues due to a combination between domestic demand and a prudent or even excessively prudent approach to exports (limiting them for a considerable amount of time in case a second infection .wave becomes a problematic threat).

The “Western abundance” mantra was essentially shattered and make no mistake, the implications of this paradigm shift are generation-defining. From the perspective of the average Western citizen, it was always assumed that as long as you have the monetary means to acquire products and services, finding them is anything but problematic, with supermarkets being always full, pharmacies always well-supplied and the list of stereotypes can go on and on. In 2020, it was revealed that the stereotypes in question are in “the emperor has no clothes” territory and that there are major supply chain fragility issues that need to be tackled in the West.

Therefore, both consumers and businesses find themselves more and more compelled to switch from the pre-2020 “ultra-optimization” consumption models which defined their way of seeing the (economic) world to more… let’s say resilient ones. In other words, it has become abundantly clear that there is indeed such a thing as over-optimization, that not everything has to be “on demand” and that yes, that it even makes sense to build a robust stockpile of at least essentials.

On a similar note, consumers have also understood to a significant enough degree that they can be just one exogenous shock away from losing their job, either temporarily or permanently. As such, it has been pretty much proven that the “optimized consumer” who was feeling good about himself due to the ability to juggle multiple loans (mortgages, credit card debt, student loans, auto loans and so on) is little more than an individual who is living paycheck to paycheck and therefore far closer to being insolvent than one would have thought prior to 2020.

Is consumerism under attack?

Most likely not, at least not consumerism as a whole.

Pre-2020 consumerism however is.

To make things sound less confusing, we firmly believe that no, the idea of consumerism will not be eliminated from the equation. Instead, less robust pre-2020 consumerism will be replaced with the post-2020 version, with the many consequences that derive from this. It remains to be seen if the worldwide economy will be able to adequately absorb such a colossal shock because make no mistake, some of the characteristics of post-2020 consumerism will be difficult to digest:

1. Less of a willingness to take on additional debt
2. An increased willingness to pay down debt
3. A greater degree of attention paid to the let’s call them bare essentials
4. Less attention paid to “expendable” products and/or services

At the end of the day, a valid case could be made that the post-2020 model revolves around a greater degree of common sense but as mentioned in other articles as well, this risks bringing society in “paradox of thrift” territory because our current model needs perpetual credit-driven growth to sustain itself and in the absence of just that, it remains to be seen whether or not some form of balance will ultimately be reached.

More so than other sovereigns, China has no choice but to adapt but truth be told, it has been transitioning to a different model well before the coronavirus became a threat. To put it differently, we are dealing with yet another (generation-defining) context which makes it clear that China has no choice but to continue with the transition from an “export powerhouse” model to one which involves a greater and greater role being played by domestic consumption and sustainability. Yet another argument in favor of the idea that the pre-2010 double-digit GDP growth days are long gone and that might not necessarily be the worst thing in the world (with China being criticized time and time again for its “growth at all costs” model which was hardly the epitome of sustainability)!

There is a reason why for example the European Central Bank, which already has interest rates in negative territory, is not rushing toward options that revolve around aggressive future cuts. They understand all too well that no, savers are not willing to tolerate anything the banking system throws at them and as such, we are close to the limit in terms of what central banks can reasonably do in terms of interest rate reductions.

This leaves the second dimension of central banking action as a potential “new paradigm” solution: monetary easing, with the most popular to the term of (in)famous term being the QE one (Quantitative Easing) used in the United States after the Great Recession. In light of the fact that the ChinaFund.com team believes we have established that there are limits in terms of rate cuts, it makes sense to ask ourselves if the same principle is valid with respect to monetary easing or, on the contrary, if we are in El Dorado territory when it comes to the latter.

As a reference point, we have the aftermath of the Great Recession, with many central banks “printing” trillions of currency units, in an attempt to provide adequate liquidity levels and thereby avoid a financial system meltdown. For example, in the case of the United States, as much as $85 billion per month were “printed” by the Federal Reserve at the height of US QE, more in one year than had existed since the year the Federal Reserve was established (1913) and up until the Great Recession. As far as the European Central Bank is concerned, it injected even more liquidity into the system at the height of its monetary easing program and the list could go on and on.

Many economists, in light of these unprecedented monetary easing measures, expected runaway inflation. Fast-forward to 2020 and, with the benefit of hindsight of course, we can safely state that no, monetary easing did not result in runaway inflation and if anything, central banks were still more concerned about deflation than inflation.

Does this mean there are no limits to monetary easing?

Has humanity found the “quick fix” it has been looking for all along, with central banks simply injecting as much liquidity into the proverbial system as necessary after a deflationary shock so as to get things back on track?

In our view… no.

Right off the bat, we need to understand that the data we have with respect to the worldwide monetary easing experiment is limited. As such, it would be premature to state that monetary easing stood the test of time.

Furthermore, we need to also look at the trajectory of the currency that was created. While central banks have controlled the “how much?” dimension by deciding how significant of a monetary easing programs they went with, they had (far) less control over what happened next. To illustrate this, we will resort to an extreme example and assume the Federal Reserve “prints” not one trillion but $999 trillion, yet simply buries the currency in question somewhere. Needless to say, there will be no inflationary effect to speak of, for the simple reason that those $999 trillion have not found their way to the “real” economy.

On a much smaller scale, the same principle was valid after the Great Recession, with a lot of currency simply being used as reserves in the banking system (hoarded, if you will) rather than finding its way to Main Street. As such, the direct effects of QE in the case of the US did not involve consumer price inflation, as it most likely would have if the Federal Reserve would have somehow distributed the $85 billion it created monthly to each US citizen. Instead, that currency found its way to the “hands” of the largest US stake holders and was indirectly used to buy various assets (stock buybacks, for example), with the end result being asset price rather than consumer price inflation.

What about the realities of 2020?

Let’s just say that this time around, from China to the United States and from South America to Europe, citizens have made it clear that they are no longer willing to tolerate a primarily “too big to fail” bailout framework and instead, demand that money ends up in the hands of the average individual as well. This became apparent in the United States, with the first Congress-passed bailout package also involving a sum of $1,200 that is to be distributed on a per-person basis, based on 2018-2019 records. The beginning of something that resembles a Universal Basic Income paradigm, if you will.

The more of the currency that is created ends up being used for consumption (especially if it offsets the deflationary effects of the 2020 crisis to a significant enough degree), the more likely it is that this time around, consumer prices actually go up… economics 101, at the end of the day. Can there be guarantees that inflation would finally become problematic? Of course not, because as always, time will tell and only let’s call them excessively optimistic/confident market participants claim to be able to predict the future. A common sense conclusion would therefore be this: while nobody can know with certainty what happens next, “prudence” is the operative word and it would therefore be wise (in the opinion of the ChinaFund.com team, at least) to exercise restraint before claiming victory for the proverbial “limitless monetary easing” camp.

This is, to pretty much nobody’s surprise, precisely what happened.

What was more than surprising, however, was the fact that few economists would have expected central banks as well as governments to be this aggressive, this coordinated and this quick to throw the proverbial kitchen sink at the problem. The Federal Reserve for example almost immediately cut interest rates by 50 basis points and then shortly thereafter brought them all the way back to zero again, with them also providing trillions in the way of financial system liquidity as well as a wide range of other solutions. Other central banks followed suit, with governments also putting their foot firmly on the pedal with respect to the fiscal stimulus dimension.

When it came to Keynesian economists, they have continuously criticized various administrations from all around the world for not being aggressive enough. In other words, for now lowering interest rates enough, for not being aggressive enough when providing liquidity (which led to a lot of it essentially being “hoarded” as banking system reserves), for under-performing on the fiscal stimulus front compared to the monetary stimulus one and so on.

Today’s situation should therefore be considered the ultimate let’s call it aggressive Keynesianism test. While there are most definitely Keynesian economists who are more reserved when talking about how low interest rates can actually go, other colleagues tend to be aggressive to the point of explaining that there is absolutely nothing to worry about because central banks still have plenty of ammunition left in this respect.

Are the latter economists correct?

As always, nobody knows because answering the question above would involve predicting the future, something human beings tend to be remarkably terrible at. Therefore, time will ultimately tell. What we can and in our opinion should do, however, is try to tackle this issue from a let’s call it game theory perspective by putting ourselves in the position of perhaps the most neglected to the point of pretty much hated (or so it seems) category of citizens: savers.

Even well before the 2020 developments, interest rates were low almost everywhere and, indeed, there have been economists who were concerned right from the beginning of the Great Recession response days that excessively low interest rates might lead to the banking system facing massive capital flight. In other words, that the average depositor would not be willing to accept letting the bank handle his money in exchange for a paltry interest rates and as such, demand cash. Needless to say, if that would have occurred at scale, the banking system as we know it would have collapsed due to the fractional reserve nature of it.

Fortunately, as we now know, it… well, didn’t.

Why?

For the most part because the average depositor is complacent. No, nobody likes receiving nothing in return as a depositor but as the joke goes, people are more likely to change their wives than their bank and as such, the overwhelming majority of depositors remained passive. The same principle is valid when it comes to negative interest rates because, and therein lies the nuance worth highlighting, they are only MARGINALLY negative. In other words, even “worst case scenario” depositors who are essentially forced to pay the bank to keep their money are only in marginally negative interest rate territory and therefore, for reasons which mostly revolve around a combination between being complacent and being scared of keeping too much money literally under the mattress, depositors didn’t exactly demand their money in cash form en masse.

However… game theory time.

We have already established that with interest rates at zero or even slightly negative (let’s say -0.1%), nobody is panicking.

What if they were lowered to -0.5%?

More likely than not, additional depositors would complain but a panic significant enough to bring about a bank run is hardly probable.

What about -1%?

In that case, let’s say (for the sake of our little thought process) that 5% of depositors would finally decide that enough is enough and ask for their money.

-2%?

Maybe 8% would decide to leave in the scenario in question, once again for the sake of our example… a percentage which would give bank managers jitters but not enough, at that point in time, to turn banks into essentially insolvent entities.

-3%?

This is where things get tricky because if 10% or more of depositors decide to leave the banking system, the equation stops working. Reserve requirements differ from jurisdiction to jurisdiction but all in all, the message should be crystal clear: as of a certain point, sooner rather than later, the percentage of depositors who decide they have had it becomes significant enough so as to put serious strain on the banking system.

The tolerance in question differs from country to country. In China and let’s say non-Western economies where inflation rates are higher than in the US or EU nations, depositors would definitely be far less likely to tolerate negative interest rates because aside from the rates in question, they would be “punished” by inflation as well. Again, it depends but as a bit of a conclusion, the ChinaFund.com team wants to make it crystal clear that yes, there is a limit as to how low central banks can go interest rate-wise and while that limit differs on a country to country basis, it isn’t that significant of a stretch to state that it might be wise to assume the tipping point in question is quite close. Wouldn’t it therefore be wise to act accordingly by no longer assuming that central banks have economic “super powers” that enable them to defy the limits of game theory and ultimately common sense?

A textbook deflationary scenario, correct?

In theory or if you will on the surface, yes.

Practically speaking, however, we need to take a major step back and look at the broader picture. More specifically, at the fact that the economic crisis came in a context where interest rates had been very low for an extended period of time (even negative in the European Union and Japan) and credit very easy to come by. This, among other things, also led to asset price inflation with respect to anything from stocks to real estate.

It also lead to other let us call them unintended consequences: a lot of capital on the sidelines.

Think of this as observation number one.

As far as observation number two is concerned, we fast-forward to 2020 and take a look at the various measures which have been implemented all over the world by governments as well as central banks, from China to the United states and from the European Union to Japan: stimulus, stimulus and more stimulus. From lowering already-low interest rates to flooding the financial system with liquidity and even sending checks to the average citizen (the Universal Basic Income concept in its infancy, if you will).

Those who had been preparing for another financial calamity “suspected” that when another financial crisis would manifest itself, central banks would resort to… well, more of the same, lowering interest rates on the one hand and providing liquidity on the other. The same way, fiscal stimulus measures were included in the equation but for the most part, the average observer expected central banks to remain in the spotlight. In the opinion of the ChinaFund.com team, however, it is fairly safe to state that not even the most pessimistic “bears” would have expected a response of 2020’s magnitude to come so quickly.

Instead, many would have expected debates upon debates among decision makers, with right-leaning ones stating that perhaps the government and central bank shouldn’t intervene very aggressively, whereas left-leaning ones would demand status quo Keynesian action. Strangely enough, that didn’t happen, with the United States representing a textbook example to that effect. A United States run by none other than the Donald Trump REPUBLICAN administration, most definitely a right-leaning one. However, instead of manifesting skepticism and giving let’s say credit to the free market, Donald Trump did the exact opposite by encouraging significant stimulus on the government as well as central bank side, to the point of even criticizing Federal Reserve Chairman Jerome Powell for not being aggressive enough at the very beginning, with Trump clearly stating that he expected the United States to “lead” (to use his exact expression) rather than follow by “out-stimulating” its competitors.

The same principle was valid in other jurisdictions and as such, fear compelled pretty much everyone to agree that an aggressive combination between monetary and fiscal stimulus (because early on, by crashing after “central banking only” responses, the market made it clear that this time around, it demands extremely strong fiscal stimulus as well aside from more aggressive monetary stimulus) is the way to go.

Libertarians agreed with Keynesians. Fiscally conservative Germans agreed with their more lenient French counterparts, the list could go on and on but this much is certain: among mainstream economists and politicians at least, it seemed that nobody dares question the fact that being aggressive is the only option.

We will now take a step back and look at our two observations: the fact that there was already quite a bit of money on the sidelines to begin with (observation one) on the one hand and the fact that unprecedentedly aggressive monetary as well as fiscal stimulus is being prescribed (observation two) on the other.

Needless to say, what was first described as a textbook deflationary scenario now seems… well, anything but. For this reason if nothing else, the “money on the sidelines” argument, it would perhaps be wise not to rush into comparisons to the Great Depression, simply because market and political conditions differ dramatically: from President Hoover who listened to his advisors and let the free market sort itself out in the aftermath of 1929 (a decision that proved to be less than ideal in hindsight) to today’s politicians, who are doing the exact opposite.

In light of the fact that Hoover’s decision has proven to be less than ideal and that today’s political decision-makers are doing the exact opposite, can or should we conclude that everything will be “fixed” properly this time around? Of course not because as we have mentioned repeatedly to the point of obsessively on ChinaFund.com, nobody can predict the future and time will ultimately tell. Therefore, no, it would be hazardous to jump to quick conclusions with respect to the glorious new paradigm of central banking and fiscal stimulus we will find ourselves in, it remains to be seen if the results will be positive or negative in the mid to long-term. What we can be close to certain of, however, is that developments will most likely be DIFFERENT this time around and as such, resorting to simplistic comparisons with the Great Depression might not be the best idea in the world. Instead, it would be wise to keep your ear even closer to the ground than usual so as to be quick to adapt to events, as they unfold. As always, the ChinaFund.com team will gladly be of assistance with just that and is only a quick message or email away.

The ChinaFund.com team, however, owes it to its readers to analyze developments in a brutally rational manner and as such, we firmly believe it is impossible to wrap your head around what has happened in 2020 without deploying level-headed thinking and an analytical framework which revolves to as low of a degree as possible on emotion.

As such, we will get right to it and, in no particular order, enumerate the various entities that have gained from disorder in 2020:

1. Entities involved in the production and/or distribution of essential items, with prices skyrocketing when it comes to certain products, for example medical equipment, for obvious reasons. The attitude of authorities varied and opinions are mixed in such instances, with pro-interventionists believing the state needs to step in and set price caps and non-interventionists claiming that by doing that, governments would be discouraging creative entrepreneurs from stepping in and filling the supply void
2. The companies behind the products and services which have become considerably more used due to the quarantine measures that have been implemented all over the world. As such, Netflix shares soared, as did stocks associated with remote communication services such as Zoom, in light of the fact that more and more individuals found themselves looking for solutions to a wide range of problems during their quarantine, from the need to be entertained (Netflix) to the need to work remotely (Zoom)
3. Certain key players in which confidence has been placed with respect to finding a solution to the COVID-19 problem, anything from biotech companies that were and are working on vaccines and other options (antiviral drugs, symptom relievers, etc.) to tech companies that are working on various ingenious ways to tackle the crisis and avoid future calamities
4. Investors and/or traders who were either short pretty much any asset other than safe haven ones (US Treasuries, for example) or long safe haven assets back in March. During times of extreme panic such as the COVID-19 episode, it should come as no surprise that a wide range of assets (risk-on assets, of course) become correlated, as market participants scrambled to generate liquidity by panic selling left and right
5. Countries that have reacted in a swift and effective manner to the COVID-19 outbreak, for example South Korea or Singapore, and have made it clear that they represent administratively mature geopolitical players. A valid case could be made that China is also included in this category, with two important mentions however. On the one hand, that its initial response left a lot to be desired (minimizing the coronavirus threat and suppressing the free flow of information) and on the other hand, that it risks being “punished” by other nation due to the supply chain complexity reduction trend that has emerged as a result of the pandemic

As can be seen, there are definitely entities that can be considered “winners” from a strictly economic perspective. When it comes to other perspectives, that can no longer be stated because again, the COVID-19 pandemic resulted in a huge number of victims and as such, glorious words such as “victory” should be used sparsely in our view.

Furthermore, even from the previously mentioned economic perspective, the situation is trickier when it comes to some “winners” compared to others, with China yet again being in the proverbial spotlight in this respect. If we are to limit our analysis to the containment measure effectiveness dimension then, of course, China can be considered a clear winner in light of the fact that its draconian containment measures (with Wuhan being a textbook example to that effect) most definitely worked.

However, upon closer and longer-term-oriented analysis, it becomes abundantly clear that a just as compelling case can be made that in the mid to long-term, China might also end up being a loser on certain fronts. To be even more specific, a wide range of economic and geopolitical actors have been made aware of the fact, more so than in the past, that relying on Chinese exports excessively can lead to bottleneck situations precisely when the exact opposite would be needed. This became more than obvious with medical supplies, as Western sellers found themselves forced to face the reality that they were dependent on either importing the final product from China or at least on key components. Regardless, the end result was the same: a severe shortage crisis which resulted in apocalyptic images involving doctors who worked in some of the world’s most efficient medical systems (Northern Italy, New York and so on) that were forced to improvise in the absence of much-needed medical supplies.

As always, time will tell and this much is certain: while there have without a doubt been entities that have come out ahead in one way or another, the term “winners” is very risky to use in light of the fact that the moral dimension needs to be considered on the one hand and on the other hand, in light of the fact that as illustrated when analyzing China’s situation, today’s apparent winners risk being anything but if the COVID-19 crisis “contributes” to a perfect storm situation in the mid to long-term.

We’ve written about the reasoning behind bailouts, why some companies are considered systemically relevant, why even approaches in the realm of the Universal Basic Income are being implemented to kickstart consumption among the general public and the list could go on and on. To put it differently, enough content to fill mountains of pages has been dedicated to how the authorities are putting out various fires.

But what about… well, the collateral damage dimension?

What about the stereotypical responsible saver, an unsophisticated market participant but one who has usually been rewarded for his willingness to defer current consumption so as to save for a rainy day. From every imaginable moral perspective, being a saver makes perfect sense. Why not build a nest egg so as to protect your family? Why engage in reckless and unsustainable credit-fueled consumption by spending money you do not have on things you do not need? Why not be “responsible” instead?

Whether we are referring to measures that have been taken to combat the Dot-Com Bubble, Great Recession or 2020 crisis, the elephant in the room in terms of collateral damage-related common denominators is relatively easy to spot: the fact that time and time again, traditional savers have been harshly punished.

How?

Through the continuous reduction of interest rates, to give the most obvious example, a reduction of such a magnitude that the days of saving money for retirement and living to a significant degree from the interest you earn during your golden years are long, long gone. Instead, it seems as if governments and especially central banks are considering traditional savers the proverbial bad guys and therefore continuously working on more and more unorthodox punishments.

Why?

Simply because, as counter-intuitive to the point of peculiar is may seem, the traditional saver is actually the number one enemy of the current worldwide economic model. An economic model which needs perpetual growth to sustain itself and at this stage in the game, that perpetual growth can only be credit-fueled.

To put it differently, we are in a clear “paradox of thrift” situation. As the name alludes to, the bottom line is this: as far as our current system is concerned (yes, even in China), behavior types which revolve around being financially responsible in the traditional sense (deferring consumption, setting money aside for a rainy day and so on) can be a great choice for an individual but if too many people were to engage in this type of behavior, the result would be disastrous for society as we know it.

Critics of consumerism believe the end of the current worldwide economic model would be a good thing, whereas the other side and especially decision-makers who do not want the world to proverbially crash and burn on their watch tends to be on the other end of the spectrum, believing that we need to do “whatever it takes” (to borrow the phrase which became iconic after being used in the right context by the former European Central Bank president Mario Draghi) to preserve the status quo. From the perspective of today’s decision-makers, traditional savers aren’t a category of market participants that deserve or need to be saved, they are a threat to the system as we know it and as such, can and should be considered collateral damage.

The elephant in the room in terms of implications is this: the days of “passively” living off interest are long gone, with savers being effectively forced to embrace a more active approach so as to not only preserve but also enhance their wealth. In an ideal situation, governments and central banks would love nothing more than for savers to embark on a consumerist journey, thereby aggressively contributing to much-desired economic growth. If that is not possible, then they should at the very least buy assets such as shares rather than hoard money under the proverbial mattress or keep it in a bank, expecting to generate something worthwhile.

An important question arises, however: aren’t too many monsters being created in the process?

To put it differently, a valid case could be made that the actions of governments and central banks are creating massive distortions, distortions we can consider unprecedented in terms of how ubiquitous they are. Make no mistake: from China to Japan, from the European Union to the United States, savers are being literally trampled on pretty much everywhere.

The effects?

Primarily the fact that bubble after bubble is being created so as to counter the effects of the previously popped one. From tech stocks which crashed and generated the bursting of the Dot-Com Bubble to measures aimed at jump-starting the economy but which also inflated an even larger bubble, the real estate one that brought us the Great Recession. Fast-forward to the present, with us living in an environment where we cannot help but notice that we are surrounded by bubbles. Furthermore, we also know that no matter what happens, the authorities will do everything they can to preserve the status quo.

Until when?

Most likely until the market ultimately decides that enough is enough, with a deflationary crash being followed by “more of the same” in terms of solutions (lower interest rates and greater injections of capital) but eventually also by the market putting an end to it all through a massive inflation-generating loss of confidence in status quo currency systems altogether. While nobody can predict the future and/or guarantee that this will happen after the 2020 economic crisis, what we can and do clearly state is this: with each cycle, the probability that something “breaks” in terms of confidence in currencies goes up and as always, we are doing our best to have all bases covered.

Why?

Simply because:

1. When times are good, large corporations are far better positioned than their smaller counterparts with respect to proverbially playing the system so as to maximize rewards. As such, the year 2010 for example (despite not that long having passed since the Great Recession, where corporations have branded themselves as innocent damsels in distress that needed to be saved to survive) brought about records in terms of executive pay and bonuses. The same way, large corporations have been more than happy to use easily obtainable capital so as to engage in share buybacks, with the net result being an increase in share prices that also helped top executives, many of whom are major holders
2. On the tax front, many of the large companies that are seeking bailouts today have been engaging in extreme tax optimization schemes, to the point that let’s say many cruise operators were sailing under the flags of nations such as Lebanon for this very reason. In stark contrast, small businesses cannot exactly afford to hire an army of lawyers/accountants and as such, are left with a comparatively higher tax burden
3. When times are bad, systemically relevant large corporations inevitably end up in the spotlight, with politicians rushing to their rescue for a wide range of reasons, from the lobbying capabilities of said corporations to the fact that a large number of jobs are on the line. Once again in stark contrast, smaller businesses don’t have nearly as large of a presence to end up on the radar of governments and central banks to as great of a degree. Of course, various bailout packages and central banking policies do mention small and medium-sized businesses as well, but how much of that is plain rhetoric and how much actual deployable money on the table?

Needless to say, this status quo is anything but sustainable because it brings about an extreme concentration of anything from market share to wealth. We therefore end up in ironical situations, for example the fact that the Great Recession was to a more than decent extent caused by large banking institutions, yet the policies which followed enabled precisely those large institutions to gobble up smaller ones and end up even more systemically risky.

Leaving mergers and acquisitions aside, there is also the ideological component or, if you will, the fact that “corporatism” as it is called (an environment where large corporations are on the receiving end of a wide range of unfair advantages) attacks the very core of capitalism by leading to a system where entrepreneurship on a granular level is inhibited dramatically. As such, the proverbial dream transitions from becoming a small business owner who starts from scratch and ultimately makes it to becoming a high-paid executive. Furthermore, any failures of this system are quickly labeled failures of capitalism despite the fact that, again, “corporatism” is indeed a better-suited term.

This status quo inevitably leads to significant build-ups of tensions and in the aftermath of the 2020 pandemic, they became more than obvious on two fronts. On the one hand, small businesses demanded to be included in the trillion-dollar bailout programs that emerged all over the world, from China to the European Union and United States. On the other hand, the average individual demanded the same treatment, which led to Universal Basic Income-like programs being implemented, which manifested themselves in the form of $1,200 being granted to eligible individuals in the United States and similar initiatives elsewhere.

The more time passes, the less other players are willing to accept the limitations of corporatism and therefore, the authorities find themselves in yet another binomial predicament. On the one hand, they can decide to turn governments and central banks into perpetual ATMs which stimulate all economic actors on the fiscal side (infrastructure investments, loan guarantees and even money deposited directly into people’s bank accounts) but risk bringing about a generalized loss of confidence in the worldwide currency system altogether, as more and more “printed” money finds its way to the real economy and leads not just to asset price inflation such as the post-Great-Recession injections but consumer price inflation this time around as well. On the other hand, they can decide to do the exact opposite by stepping back and letting the market sort itself out, knowing that they risk about bringing about another 1929-style Great Depression.

This much is certain: in pretty much all jurisdictions, small and medium-sized businesses as well as the average individual are making it clear that the Great Recession approach (heavily favoring large corporations) will no longer be tolerated. Therefore, stimulus programs from all around the world carry much greater weight in this direction and it remains to be seen what the long-term consequences will ultimately be.

For the time being, it is not difficult to observer that the “universal ATM” approach is chosen all over the world. As the dust settles, it once again remains to be seen what the consequences (if any) in terms of confidence loss in the worldwide currency system will be. Ask a libertarian and he will state that the system is doomed. Ask a Keynesian and he is likely to state that the status quo is not at risk. Ask the ChinaFund.com team and we will quickly provide the only honest answer in this context: we don’t know, neither does anyone else and for this reason, the only approach that makes sense revolves around keeping our ear to the ground and reacting to the events which unfold as quickly as possible, with us of course keeping readers and especially clients posted.

Is the end of globalization near?

Right off the bat, we want to make it clear that this article is firmly in the realm of speculation and merely reflects the opinion of the ChinaFund.com team. At the end of the day, nobody truly knows what the future has in store and those who claim they do are nothing but charlatans or, to use another term, snake oil salesmen.

In our view, the word “end” tends to be too harsh.

No, we do not believe that the end of globalization is nigh, for the simple reason that the current well-functioning of the worldwide economy depends on it to such a degree that it is just not feasible to assume we can simply erase it from the equation altogether. The logistics of it all make too little sense for us to consider using the word in question.

On the other hand, we do understand that there is a lot in the way of incentives to “combat” globalization in one way or another. Even well before 2020’s developments, frustration levels within Western nations were sky-high from the perspective of the average worker in general and especially blue-collar worker in particular. To put it differently, the lower-skilled a Western worker is, the less he has taken advantage of everything the modern-day economic system has to offer.

In stark contrast, higher-skilled employees who let’s say work in the service sector have done remarkably well. For example, a high-end IT professional, even if he went into debt so as to get a good college degree, can almost immediately find employment opportunities that put his professional life well on the path toward financial sustainability. It isn’t the least bit difficult to understand how, from the perspective of such a person, things seem to be going amazing: they have more than enough money coming in that they can spend (among other things) on cheap imported goods, what’s not to love about globalization?

The more time passes however, the more people enter the former category. Even among the previously mentioned IT professionals, there is a deep divide. A gap, if you will, between those who aren’t affected by globalization and those who are. For example, an average Western programmer who specializes in the most widely-used languages, let’s say a LAMP programmer (Linux – Apache – MySQL – PHP), will have severe difficulties competing with a similar programmer from a poorer nation and as such, will gradually develop resentment toward globalization much more so than an in-house Western employer who is ultra-specialized and feels more than secure financially. This much is certain: the number of frustrated Westerners has been growing continuously over the years and if anything, the year 2016 has proven that critical mass has been reached.

However, we would argue that this doesn’t mark the end of globalization altogether but rather… well, the end of globalization as we know it.

2020’s developments are a textbook example to this effect and will almost certainly generate short, mid as well as long-term changes with respect to supply chain complexity reduction for vital goods. For example, Western politicians will encourage let’s say those who sell protective medical gear far more aggressively to move as much as possible in the way of production back home so that repeats of the 2020 situation do not occur (with Western nations who were desperate for medical supplies so as to combat the COVID-19 pandemic experiencing major bottleneck issues due to being overly-dependent on China).

Furthermore, in light of the fact that a wide range of businesses have been affected to such a degree by the economic aftermath of the COVID-19 pandemic that they required government assistance, it shouldn’t come as a surprise that in some cases, assistance came with strings attached. Strings which oftentimes also revolve around, of course, moving production back home.

For these reasons and many more, a fair case can be made that it would be optimistic to the point of naïve to assume that globalization can find a way to survive “unharmed” after a perfect storm-type cataclysm such as the COVID-19 pandemic. On the other hand, it would be equally optimistic to the point of naïve for the proverbial other side to believe that autarky is anything but a utopic scenario or in other words, that globalization can and will be eliminated from the equation altogether. Whether we are referring to logistical reasons, geopolitical considerations or even business common sense, it should be obvious that moving away from globalization altogether is… well, pretty much impossible.

This, however, doesn’t mean there won’t be consequences for the proverbial spoiled children of globalization (as they are perceived by the West, at least) such as China. In some cases due to their own mistakes and in others as a result of exogenous shocks, nations such as China will have no choice but to adapt to the post-2020 realities and focus more on trends pertaining to unleashing their domestic consumption potential, a model China was already embracing well before the coronavirus became a threat. At the end of the day, as complex as the equation may seem, it all starts making sense once you meaningfully “get” China and understand the stage of economic development it is currently at. As always, if that is not yet the case as far as you and/or your organization are concerned, the ChinaFud.com team will gladly be of assistance and is only one quick message away.