China is in a unique position among major economies of having low inflation and low interest rates. The Chinese economy has slowed down considerably in the past year and may already be in recession, although the official data obscures that reality.
Part of this slowdown is due to the breakdown of global supply chains, reduced demand from foreign buyers of Chinese goods in Europe and North America, and the damage from the real estate collapse in China.
Still, a large part of the economic slowdown is self-inflicted damage from China’s misguided and absurd ‘Dynamic Zero’ COVID policy in reaction to the pandemic. This is a major factor in the global slowdown.
We’ve written extensively about China’s ‘Dynamic Zero’ COVID policy in other contexts. Today, it’s wrecking China’s economy. Still, the story keeps getting worse and demands our time and attention.
The ‘Dynamic Zero’ COVID policy was invented by Communist Party Chairman Xi Jinping. The policy relies on public health officials, city officials, police, and Communist Party cadres for its full implementation. Under the policy, a single case of COVID can result in an entire building being placed under quarantine. Multiple cases in a single neighbourhood will result in the entire section of a town being placed under quarantine. More than 10 cases or so can result in an entire city being locked down.
This applies to the biggest cities in China, including Shanghai (population 26 million) and Beijing (population 22 million). These lockdowns are more than an inconvenience — they’re extreme. Tens of thousands of those in contact with the infected are physically relocated to COVID concentration camps on the outskirts of the cities. Anyone seen on the streets without permission is arrested on sight.
Transportation linkages into and out of the cities are shut down except for the few who have special permission to travel. For those allowed out to perform essential services, testing centres are set up on street corners every few blocks, and tests are administered daily.
No sooner does one city come out of a lockdown than another city becomes the victim of a new lockdown. China says this is all necessary to ‘defeat’ the virus. But that’s absurd. The SARS-CoV-2 virus that causes COVID is highly infectious and is airborne, so it goes where it wants. No amount of testing or lockdowns will stop the spread. The official Chinese vaccine from Sinovac doesn’t stop infection or the spread of the disease (neither do the Pfizer or Moderna vaccines we use), so that’s not a factor.
The real problem is that the Chinese haven’t reached the stage of herd immunity. The best vaccine is the disease itself. Cases are usually mild or asymptomatic and the antibodies that result from actual infection are the best defence against getting the disease again or spreading it. Since the Chinese use extreme lockdowns instead, they don’t achieve herd immunity and they can’t get past the pandemic in the way that the US, Europe, and others already have.
China is destroying its economy in this losing game of Whack-a-Mole. Factories are closed during lockdowns, supply chains are disrupted by shutdowns in transportation lanes, and productivity is crushed by the time spent in lines for testing or in concentration camps.
Why does China persist in such a pointless and costly effort? The unspoken reason is that Chairman Xi is scheduled to be appointed to an unprecedented third term as President this November at the 20th National Party Congress. Xi doesn’t want to admit defeat by COVID and doesn’t want to embarrass himself by admitting his policy was wrong. So he persists at great cost. This is how ideology trumps science and common sense. The losers are the Chinese people — and investors in China.
[Note: Today’s article was originally published in July 2022.]
United Kingdom (UK) — depreciating the pound
The UK is high on the list of high-rate, high-inflation developed economies as shown in the charts above. The expected policy path is similar to the US, with two important differences.
The UK has already raised interest rates from 0.25% to 1.25% in the past six months, roughly the same as the US. But now the Bank of England has signalled they may raise at a slower tempo going forward. While the Fed has already signalled a 0.75% rate hike at its July meeting and possibly beyond, the BoE has indicated that future rate hikes may be only 0.50% or less.
This makes sense. If rate hikes are going to lead to a hard landing in terms of demand destruction and recession, then slightly lower rate hikes have a better chance of achieving a soft landing consisting of reduced inflation without a sharp recession. In fact, the UK may already be in a recession, but early indicators show that it may be mild. April GDP was only 0.4% below January’s GDP, a better performance than the US.
The UK also has a secret weapon not available to the US. This is depreciation of their currency against the US dollar, another example of the classic currency war strategy. The pound is down 14% from its post-Brexit high in 2021 and is close to the bottom of its six-year trading range at $1.22. A further depreciation, which seems likely, would give UK exports (and tourism) a boost and possibly avoid a hard landing even if a mild recession-style soft landing is already in the cards.
Japan — a yen problem
Japan is like China in the sense that it doesn’t fit the high inflation/high interest rate pattern of the rest of the major economies. Inflation in May 2022 was only 2.5%, and interest rates as of June were negative 0.10%.
Still, that level of inflation is high by Japanese standards; Japan has been in eight recessions in the past 30 years — really, it’s been a long depression, with persistent deflation rather than inflation.
Based on that situation, one would expect that the Bank of Japan (BoJ) will raise interest rates, however slightly, to slow the rate of inflation. Alternatively, the BoJ could raise the cap on yields on 10-year Japanese Government Bonds (JGBs) by buying fewer bonds and letting intermediate-term rates rise slightly. This policy is what the BoJ calls Yield Curve Control or YCC.
In fact, Japan will do neither. The reason is idiosyncratic to the system of Japanese finance and government.
The Governor of the Bank of Japan is Haruhiko Kuroda. His term as head of the BoJ ends in April 2023. He’s 77 years old and is the longest-serving head of the BoJ. Kuroda is unlikely to be reappointed and is now planning to retire as of next April. He’s looking forward to what the Japanese call ‘amakudari’ or the ‘descent from heaven’, which describes retirement from a senior government job. The retiree can look forward to a remunerative post-retirement with appointments to think tanks, institutes, and private company boards.
Kuroda is literally counting the days. If he makes any important policy moves, he has very little upside and enormous downside if his moves trigger a market panic or financial crisis. So, he’ll do nothing to jeopardise his ‘amakudari’. Kuroda will leave monetary policy to his successor.
That makes forecasting the Japanese economy extremely straightforward, at least in the short run. Kuroda will not raise interest rates. He will continue YCC by buying as many JGBs as necessary to keep a lid on intermediate-term rates. With both forms of monetary ease in play, inflation will increase slightly. The biggest impact will be a continued extreme decline in the exchange value of the yen, another form of monetary ease, and another facet of the currency wars.
Keep an eye out next Wednesday for the fourth and final part of this series of articles.
All the best,
Strategist, The Daily Reckoning Australia
This content was originally published by Jim Rickards’ Strategic Intelligence Australia, a financial advisory newsletter designed to help you protect your wealth and potentially profit from unseen world events. Learn more here.