Economic Commentary and Forecasts, February 2024

Same old setup: mostly conclusions, with a little reasoning here and there.

China

First, the commentary.

The plunge in Chinese stocks reflects trouble in the underlying economy. But the four markets that really deserve watching are stocks, bonds, property and foreign exchange.

If the economic problems keep festering, they may spill over into politics.

Every stock-market rescue now under way is designed to make money. Yes, make money, not rescue the market.

A measure that could actually save the market is simple. Leaving the big ones aside, just let retail investors short stocks and the indices would rebound at once.

I still think the current decline is healthy, even if it turns into a sustained crash. This is simply fundamentals working their way through the system. The fact that stock prices can still register that signal shows that the market's structure makes sense and its chain of logic still works.

China's economic problem lies in the economy. Trying to save it by saving the stock market gets cause and effect backwards.

The RMB has remained broadly stable, so the central bank must have spent a lot of real money defending it. I fear that will prove futile in the end.

The current approach to local government debt seems to be bank liquidity and maturity extensions. That is basically the only option. But it will gradually increase the liquidity pressure on banks, which is why the central bank is cutting reserve requirements at the same time. I expect those cuts to recur.

The central bank's rate cuts are too small and too slow, perhaps because it is afraid the exchange rate will not hold.

The central bank and Ministry of Finance keep trying to have everything both ways. Compared with the Fed's willingness to bite the bullet and move decisively... heh.

Purchase restrictions are gradually being relaxed in first- and second-tier cities. That may suck demand away from smaller cities and put enormous pressure on housing prices there. My view remains the same: judge a city's housing market by its population inflow-to-outflow ratio.

Back to the four markets. It is not hard to see the order of priority: FX > bonds > stocks > property. Employment is another part of the logic. The number of jobs represented by foreign trade, local government debt, the stock market and property determines how high each market sits on the protection list.

From low to high:

• Property is already a mature market with little room to expand and few new jobs to offer, so it comes last.

• The stock market's "jobs" can disappear without doing much to the employment rate. Pure stock traders already belong to the "unemployed population." But the market has a large social impact, so it cannot simply be abandoned.

• Foreign trade is a major source of employment, so it comes first.

• If local government debt implodes, it will drag down the banks, then government credit, then the whole civil-servant employment system. Even so, that system accounts for fewer jobs than the foreign-trade system, and the banks can still hold on for a while. So debt comes second.

Now the forecasts.

• The bottom for A-shares, specifically the Shanghai market, is somewhere between 2,300 and 2,500. Once leveraged positions have been fully cleared out, it should offer a decent buying opportunity.

• If the index breaks below 2,300, China may see social unrest.

• Stopping people from selling in order to halt a market decline is a very Chinese solution. A market that may only rise and never fall is no longer a market. A non-market rescue is the worst damage one can do to the stock market.

But China's economic resilience should not be ignored. The actual standard of living in its first-, second- and third-tier cities is already quite high. That is the most important foundation beneath the economy. It is also why the odds of the Chinese collapse some China-bashing idiots are rooting for are basically...

Europe

I am extremely pessimistic overall. As the likelihood of Trump returning to office after the 2024 US election rises, Europe's investments over the past few years in war, environmental policy and energy diversification may all come to nothing. Those bets have not only burned through Europe's capital; they will keep showing up in taxes on households and businesses.

Europe's left-wing political climate has created a powerful push toward deindustrialisation, even though traditional industry is one of the few areas in which Europe still leads the world. That suicidal tendency, combined with the failed investments above, makes Europe's outlook very bleak.

If the political wind turns right and protectionism rises, Europe may inflict even more pain on its own economy. Over the long run, it may also find itself making repeated 180-degree turns, or the 360-degree turn once advertised by Germany's foreign minister.

The United States

Thanks to the Fed's masterful control, the United States has the strongest growth among the world's major economies. The Biden administration has taken criticism from every direction, but America still holds a commanding lead in technology. If Trump returns in 2024, the country already has the foundations to pull production, capital and talent back in.

America's weakness is social division. But if that division exists, fast economic growth may do a good job of mending it. And who knows whether today's "social division" is real, or whether it has simply been manufactured.

My verdict on the United States: neutral.

Japan

Japan has spent these years keeping its head down, growing quietly and not getting cocky. In my previous forecast I was already bullish on its economy, and the Nikkei has duly kept climbing.

The key to Japan's development comes down to four Chinese characters: seek truth from facts. Japan has identified its strengths and weaknesses accurately and learned useful lessons from its past.

On that basis, it moved upstream in the supply chain and kept negative interest rates for years. It paid for this with a persistently weaker yen, but preserved steady export growth. Moving its traditional technological strengths upstream also helped it avoid trade fights over finished products.

Of course, Japan's ageing population and its economic concentration in a few industries remain risks that cannot be ignored.

My verdict on Japan: cautiously optimistic.

That is enough rambling. There is not much hard material in this one. Think of it as a record.