China, the United States and the EU in the Context of the Next Financial Crisis


Never before has this much time passed between recessions than at this point, with the 2007-2008 Global Financial Crisis (commonly referred to as the Great Recession) seeming like a distant memory… this should mean it’s time to celebrate, right? After all, so much prosperity that will seemingly never end must be a good thing… or maybe not?

It ultimately all depends on the nature of the expansion.

Under “old school” circumstances, if we would have been in a strong expansion which led to countries getting their deficits under control (or… may I say it, even experience a surplus here and there), in a general climate of geopolitical stability and cooperation then sure, I would have been the first one to congratulate all parties involved.

However, in many respects, we are dealing with the exact opposite:

  1. Countries are more reckless than ever, with sky-high deficits and debt levels which instead of being lower than the levels experienced in the days of the Great Recession, are higher in pretty much all cases. If borrowing yourself out of trouble is indeed the way to go, we are all set. Otherwise, someone will eventually have to foot the bill. Plus interest. Plus damages
  2. The market has been numbed to the point of “zombification” by interest rates at ridiculously low levels, even negative territory such as the European Union. Leaving aside the fact that easy access to capital has been perhaps the main cause of the Great Recession, those circumstances were a walk in the park compared to the situation we find ourselves in today. While interest rates were indeed brought down to the 1% zone from ~6.25% by Alan Greenspan after the Dot-Com Bubble, at least they had a chance to normalize (even if not 100%), reaching the 5% area in the US. Nowadays, over 10 years later, the interest rate “normalization” process is beyond anemic in the US and the United States are actually not in the worst shape in the respect
  3. After the Dot-Com bubble, lowering interest rates was enough of a shock for markets. After the Great Recession, however, the market demanded more. Much like an addict who requires an ever-increasing dose to function normally, the market ended up receiving not just lower interest rates (all the way down to zero in the US and negative in the EU) but even downright injections of capital, reaching a high of $85 billion per month in the United States and even more in the EU. From 1918 up until the Great Recession, the monetary base hadn’t even reached $900 billion in the United States, yet at the height of its Quantitative Easing process… over $1 trillion were pumped into the system in a single year
  4. Adding insult to injury, countries were quick to embark on currency devaluation journeys, leading to (in)famous currency wars, which then escalated to downright trade wars threats, as today’s geopolitical landscape makes clear. While past performance is not necessarily indicative of future results, it is worth noting that whenever this happened throughout history (financial crisis, followed by currency wars and ultimately trade wars), what followed wasn’t pretty

… the list could go on and on.

As can be seen, not only have imbalances not been corrected, they’ve been exacerbated on absolutely all fronts. While the economy hasn’t crashed since and fortunes have actually been lost shorting various markets (after all, the market can remain irrational longer than you can stay solvent), a fairly obvious conclusion arises: we are most definitely on borrowed time.

A just as obvious follow-up question emerges: what’s likely to happen to major players such as China, the United States and the European Union when the next financial crisis finally emerges?

In light of the fact that China is our main area of interest, it’s worth noting that those who are exploring investment opportunities in China are doing the right thing, secularly speaking. For many reasons which have been covered extensively on, not only is China poised to become the #1 economy of the world by nominal GDP, there is still so much room to grow that it can reach levels which make country #2 seem like an economic dwarf in comparison.

However, this is an observation in the context of the multi-generational China mega-trend we are in the middle of.

In the meantime, many market participants still treat China as an emerging economy and as such, they are quite likely to exit their positions when the overall market sentiment goes from risk-on to risk-off. In contrast, the same investors tend to flock to assets such as US Treasuries during times of distress, as a safe haven of last resort.

Eventually, the safe haven perception might disappear but until that happens, seemingly ironic chains of events can occur. For example, what happened after the Great Recession, which had its origins deep in the United States Mortgage-Backed Security debacle? Ironically enough, investors fled emerging markets and allocated capital toward safe haven US assets… despite the fact that the crisis itself started in the United States.

The same way, we can expect such a pattern to keep manifesting itself until the market decides to re-consider what is and isn’t considered a safe haven asset. At the end of the day, based on the “status quo” pecking order for lack of a better term, investors are likely to withdraw from China before they withdraw from most European Union countries and withdraw from most European Union countries before they even think about touching their United States safe haven assets.

What are the implications for you as an investor with a meaningful interest in China?

Simply put, this can represent a generation-defining investment opportunity to acquire the best of the best in terms of Chinese assets at a deep discount. Think of it as a contrarian trade or however you choose to phrase things, the bottom line is this: when you believe a market is poised for long-term growth in a way which makes everything else pale in comparison, buying the proverbial dip is the way to go.

In other words, when everyone is panicking and selling assets in China at pennies on the dollar, that is precisely the best possible time to make your move if you are liquid enough to be able to do so. As Warren Buffett would say, a textbook example of being greedy when others are fearful and fearful when others are greedy.

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