China in the Context of a (Great) Depression?


Time and time again, analysts are voicing concerns about a potential recession in China, especially in a post-coronavirus framework. For example, scenarios which involve let’s say a one-year economic contraction, with the many consequences this brings about… not just for China but for everyone else as well, in the context of a deeply interconnected economy where if a major country sneezes, everyone else catches a cold.

Before continuing with this article, we would strongly recommend reading our post about recessions from a Chinese perspective, an article which can be accessed by clicking HERE. As explained in the article in question, the effects of even relatively “mild” recessions can be systemically relevant due to the fact that… well, we are in unprecedented territory when it comes to a wide range of market conditions: the previously mentioned economic interconnectedness, record-low interest rates for a prolonged period of time, financial markets that have become dependent on swift action by central banks and the list could go on and on.

For a graphical representation of this phenomenon, simply take a look at any chart that depicts GDP growth over in the US and you will see that the Great Recession represented a mere blip on that chart. In other words, that one seemingly minor GDP growth blip was enough to risk bringing about the end of our financial system.

On the surface, it seems downright tempting to analyze a potential upcoming recession by looking at it through a Great Recession or even Dot-Com Bubble lens. In other words, assuming there will be a deflationary event, followed by central banks doing more of the same (lowering interest rates further and injecting money into the system via more or less unorthodox monetary easing programs) and then a relatively straightforward asset price recovery across the board… business as usual in other words.

The team firmly believes this would be an extremely dangerous attitude to have for a wide range of reasons, such as the fact that Alan Greenspan did not properly tackle the root causes of the Dot-Com Bubble and instead, simply opted for the relatively straightforward option of “bribing” the market with low interest rates, an option which “fixed” the asset price decrease issue but inflated an even bigger bubble, the real estate one. When that burst, Ben Bernanke essentially decided to do the same by kicking the can down the road for another cycle rather than tackling root causes. Except that this time, the market demanded more and as such, lowering interest rates was no longer enough… money had to be injected into the system to the tune of $85 billion at the height of QE, with other nations following suit. Is it really wise to assume that “more of the same” will keep representing a strategy that works?

Even if we were to assume that central banks will always get it right, can all problems be tackled by them? While a central bank can lower interest rates and inject money into the system, it cannot handle a worldwide pandemic for example… it cannot get factories re-opened, it cannot easily re-ignite spending (the velocity of money) and the list could go on and on. In other words, the limits of central banking interventionism will eventually become obvious.

The main message we are trying to get across is that it might be wise to have a contingency plan for situations in which “status quo“ central banking actions either no longer work as intended or, worse yet, backfire and trigger a worldwide depression.

Could this phenomenon have China as its epicenter?


Could it have the United States as its epicenter?

Once again, of course.

At the end of the day, it matters little where it starts in the context of our deeply interconnected worldwide economy. What matters is that eventually, we will have to deal with not just relatively mild recessions that are kept in check via aggressively dovish central banking policies but rather with an out of control spiral into depression territory.

How would things unfold?

We do not know.

How would China be affected?

We do not know.

As disconcerting as this may sound, the brutally honest truth is that in light of how unprecedented today’s market conditions are, nobody actually knows how a potential worldwide depression is likely to unfold.

Don’t we have the 1929 Great Depression as a comparison?

To a certain degree, yes. However, comparing today’s deeply interconnected economy to its 1929-era counterpart is most definitely a strategy that has its limits. As such, while there will most likely be common denominators, expecting the unexpected is the operative attitude when dealing with unprecedented market conditions.

Why write this article, then?

Simple: to get you to think about this scenario… now.

Not a week from now, not ten months from now. The best time to prepare for scenarios of such magnitude is right now and by at least thinking about how a worldwide depression would affect you and/or your organization, you are automatically miles ahead of the average market participant.

What we can offer as a quick tip would be this: embrace your incompetence when it comes to predicting the future, don’t hide from it by seeking a false sense of security in strategies offered/sold by one guru or another. Accept the fact that you do not know what will happen, accept the fact that those who claim they do are nothing more than charlatans and put together a robust strategy that enables you to land on your feet under a wide range of scenarios.

To that effect, the team would be happy to help. If we had a working crystal ball (hint: nobody does), we would love nothing more than to identify the correct scenario and go all-in. In light of the fact that it is impossible, the next best thing is aiming for robust diversification through a portfolio that consists of meaningfully uncorrelated assets. It is the hardest possible road to take and therefore… well, most likely the correct one.