America and China have traded places
Investors and economists continue to be confounded by the resilience of the American economy.
The latest data suggests that corporate investment continues to defy the lofty Fed funds rate, even as executive confidence remains depressed (Chart 1). Part of the capital expenditure story is secular, with technological innovation allowing companies to redraw their supply chains via automation.
But much of it is also cyclical, with the gargantuan US fiscal stimulus remaining trapped on households’ balance sheets (Chart 2). Some of it is also geopolitical, with governments around the world looking to emphasize just-in-case (over just-in-time) inventories and the resiliency of supply chains. All three are forcing American CEOs to invest – no matter what they are “feeling.”
In some ways, the US is experiencing a capex-led cycle, akin to China’s post-WTO entry push in the early 2000s. China, on the other hand, is living through America’s nightmare of the past cycle.
Chinese policymakers seem to believe that the malaise is temporary – merely a product of low confidence among households and corporates that had to navigate tough zero-Covid policies through 2022. But in my view, Covid-19 was merely an acute episode. The chronic illness is the massive debt load in China’s corporate and household sectors. China’s household debt level relative to disposable income is the highest among major economies (Chart 3).
China is mired in a deflationary debt spiral (Chart 4) as its households remain focused on deleveraging (Chart 5). The surge in private-sector savings (Chart 6) is a form of structural demand loss (Chart 7).
Like the US prior to 2008, Chinese household leverage is concentrated in property. Every time that external demand lagged in the 2010s, Beijing’s policymakers used the household credit lever, propping up the economy by stimulating real estate (Chart 8). They have now decided to stop the debt supercycle, with predictable outcomes. Prices are deflating (Chart 9), while property sales are contracting (Chart 10). While there are secular reasons for the flagging demand – such as negative effects from demographics (Chart 11) – the main culprit is the unwillingness of policymakers to deal with the private-sector balance-sheet recession.
In the West, the secular stagnation cycle post-2008 took nearly a decade to resolve. This was primarily because policymakers failed to heed the advice that fiscal stimulus was the only way to deal with private-sector deleveraging.
In both the US and Europe, policymakers stuck to monetary policy, eschewing the fiscal lever. Politics played a major role, with the rise of the Tea Party in the US and the austerity fetish in Europe delaying the fiscal response. Once populist outcomes began to mount – particularly in the monumental year of 2016 – the fiscal lever was re-engaged with gusto.
In our view, it is unlikely that Beijing will wait seven years (as the West did) to cycle through such a rate cuts-QE-fiscal stimulus playbook. Political pressures are already building, with youth unemployment and household income indicative of a deep domestic malaise.
Ultimately, the West responded to its own balance-sheet recession with stimulus. China will as well, but likely on a faster time horizon. When that moment comes, it will combine with the investment boom in the US to create a significant capex-led cycle.
Such cycles tend to be positive for global equities and commodities and negative for bonds (Chart 12). The exact opposite, in other words, of what worked during the post-GFC, secular stagnation, “risk parity” cycle.
As long as Beijing hesitates, however, investors won’t know which paradigm they are in. There might be a lot more push-and-pull between the risk-parity default setting of most investors and the capex-led cycle yearned for by value investors, commodity bulls, and fans of cyclical assets.
But once China puts a floor under its growth, the shift to the new paradigm should become clear.