Separate Ways, Worlds Apart
For many months, we have focused almost unilaterally on the path of tightening by the Federal Reserve, and what the next leg of that journey may look like. The concern has been, and remains, how much pain rate hikes, inflation, and quantitative tightening will inflict on markets.
Meanwhile, on the other side of the world, yet not far away economically, the People’s Bank of China (PBOC) is cutting rates to stimulate borrowing and growth. China is the second largest economy in the world by nominal GDP (U.S. being the largest), and the biggest consumer of raw materials in the world. According to data by the Wall Street Journal, China consumes about 15% of the world’s oil, and imports more crude oil than any other country.
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Not surprisingly, when a culmination of weak economic data and fears of a further slowdown resulted in the PBOC cutting rates on Aug 15th, Brent Crude Oil prices hit the skids.
After that surprise cut, the PBOC engaged in more cuts to key lending rates on Aug 22nd. But the global effect of slowing growth in China reaches beyond commodity markets. Regional currency markets have seen steep declines, and fears of ripple effects among China’s biggest trading partners have shifted front-and-center. This is all on top of a nosedive in Chinese consumer confidence, high and rising youth unemployment rates, and a crumbling property sector.
When the Lights Go Down
While the U.S. desperately attempts to cool inflation, driven in part by excess liquidity and ballooning money supply, China is attempting to increase liquidity. One of the most widely used measures of money supply is M2 , which can be summarized as cash, or things that can be quickly converted into cash such as money market securities.
A simple comparison of what’s happened in the U.S. with M2 vs. what’s happened in China is illustrative of the divergence in current policies.
What’s even more interesting to note is that China never went through the exceptionally large spike in money supply that the U.S. did, even during the depths of the Covid-19 crisis. Their stance would be that they prefer to prevent an increase in inflation by not injecting excess liquidity into the system, while U.S. policymakers may argue that the lack of policy support (in comparison) led to China’s current growth challenges.
I’m not here to argue one side or the other. If I’m being honest, I think we both have pretty serious problems to contend with. What I will say is that this divergence in Central Bank policies among the world’s two largest economies is something to pay close attention to. The chances of both monetary authorities having done it “right” and succeeding in bringing their respective economies back into balance, while simultaneously moving in completely opposite directions, is difficult to imagine.
Wheel in the Sky Keeps on Turning
One of the most counter-intuitive lessons every investor has to learn is that dislocations, although uncomfortable and at times nonsensical, create opportunity. In this case, that may end up being true, but not as of yet. As the song goes, truth can be found in the lyrics “Wheel in the sky keeps on turning, I don’t know where I’ll be tomorrow.”
Central bank policies may be different across regions, but economic weakness is something we’re dealing with globally. Despite the beginning of a stimulative cycle in China, there is still too much uncertainty surrounding some of the key parts of their economy for me to see this as “good assets on sale.” For now, let’s let China stimulate while we restrict, and do one of the other counter-intuitive investor behaviors…sit on our hands.
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