The China Syndrome

The economic news out of China is going from bad to worse. The world continues to bet on massive government stimulus, but it never seems to happen. Could a melt-down be coming? (For you non-movie buffs, China Syndrome is a 1979 movie about a nuclear meltdown, that amazingly was released a mere 12 days before the Three Mile Island nuclear accident in Pennsylvania.)

• Youth unemployment has officially reached 21%, and given the quality of data from China, it would not be surprising if reality is even higher.
• After the massive Evergrande default in 2021, the Chinese property market is still on the ropes as Country Garden has missed an interest payment and is in the 30 day grace period to make the payments. Until recently, Country Garden was the largest private-sector real estate developer in China.
• China GDP growth has slowed. As noted by CNBC: “The 6.3% GDP print for the second quarter marked a 0.8% pace of growth from the first quarter, slower than the 2.2% quarter-on-quarter pace recorded in the first three months of the year.”

The question remains: Is this a problem of the Chinese consumer retrenching, or is it a sign that global demand is weakening? Or could it be both? The outcome here is binary: A massive stimulus package would be considered a positive for global markets. More money sloshing around = higher asset values. If they don’t pull the trigger on stimulus, the threat of economic erosion becomes more real and would be negative for global markets.

Saying the Quiet Part Out Loud

As we reach the first anniversary of the Inflation Reduction Act (IRA), we found it rather amusing that President Biden had this to say about it this week: “I wish I hadn’t called it that. It has less to do with reducing inflation than it does providing for alternatives that generate economic growth.” Wait, wasn’t that what the GOP was saying before it passed? You just can’t make this stuff up!

More important, the Inflation Reduction Act (IRA), as well as the CHIPS Act and the Bipartisan Infrastructure Law (BIL) may be the reasons that the economy has held up so well. The historical policy response to a recession is some form of fiscal stimulus (i.e., deficit spending). This cycle, we appear to have reversed the order, and we have ramped up fiscal stimulus before the recession.

Here’s an example, when passed last year, it was estimated that the IRA would add some $400 billion of deficit spending over 10 years on clean energy projects. A year later, that looks like it’s going to be closer to $1.2 trillion and it continues to grow. We are getting far more stimulus than expected. Of course, all this spending is happening at a time that the Fed wants growth to slow down in order to contain inflation. The irony is that the Inflation Reduction Act is acting counter to the Fed’s effort to slow inflation.

Irony of ironies, this is the exact opposite of the period from the 2008-09 housing crisis up to the pandemic. During that period, the Fed was more concerned about deflation and looking to promote growth. The Fed practically begged Congress to pass some fiscal stimulus to help them out, but Congress failed to act. If we successfully exit this cycle without much damage, it will be despite our best efforts to sabotage our own economy.

The economic question that appears to be the most pressing today is whether this unexpected fiscal spending merely delays a recession, or eliminates the recession altogether for this cycle. On the surface, it’s easy to think that eliminating the recession would be the best option, but we need to be careful what we wish for. If the economy just keeps rolling along (i.e., the ‘no landing’ scenario) it will be very difficult to get inflation under control. The logical response from the Fed would then be to stomp the economic brakes that much harder, which would most certainly result in a recession and a potentially bad recession at that (the hard landing scenario).

The Goldilocks scenario, where the economy is not too hot and not too cold (also known as the ‘soft landing’ scenario) is the best option as the economy slows, inflation recedes and we can then start a new cycle without instigating a recession. History teaches us that this scenario is not impossible, but highly improbable.

The bottom line is that economic indicators continue to point in inconsistent directions, so prognostications are prone to inaccuracy. But given enough time, everyone may be right. The unexpected economic strength may well save us from recession in the short term, but not the longer term. Recession delayed, but not eliminated.

What We’re Reading

July CPI report shows inflation gauge rose 3.2%, less than expected

U.S. wholesale prices surprise to the upside in July

Biden Walks a China Tech Tightrope

Chinese Property Giant Country Garden Sends Another Distress Signal

China stocks fall as consumer prices drop for the first time in more than 2 years

“Block after block is just ash”: What it’s like in fire-ravaged Lahaina

Palumbo Wealth Management (PWM) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where PWM and its representatives are properly licensed or exempt from licensure. For additional information, please visit our website at www.palumbowm.com.

The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.

The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.

General News

By: thinkhouse