Dragon cough

China is normally a fire breathing dragon.

And to fuel this fire requires the dragon to devour a massive amount of natural resources.

Globally speaking, China eats >70% of the world’s iron ore, 60% of all of the nickel, 42% of global copper supply and 25% of global energy. It’s also the world’s largest producer and consumer of aluminium.

Putting food commodities aside, the belly of the dragon is the world’s factory.

So, it should come as no surprise that any material weakness in its ability to keep its factory open and stomach fed does not bode well for the global economy.

And that’s what’s happening now.

In seeking to slay the virus, Xi’s zero-COVID policy, continued labour lockdowns, disrupted energy and basic material supply chains have led to GDP contraction and price deflation in almost all of China’s main factors of production. It’s a bad cough that could get worse.

Meanwhile in the West, inflation is public enemy number one, but interest rate hike retaliations from key central banks are not helping main street, nor are they fullhearted. They’ve recently gone off their pre-set courses and are now data dependent.

Given the ripple effect that a coughing dragon can have on a geo-politically broken world post-Ukraine, particularly in the West and North and amongst other emerging markets in the South, it’s worth keeping a watchful eye on happenings in the East.

Here are some key stats to keep an eye on.

China GDP growth decelerates

Other than for the first Wuhan lockdown in early 2020 when Q1 GDP decreased by 10.3% on Q1 2019, we have just witnessed the first quarter on quarter deceleration in China GDP for at least the last 6 years.

Q3 will be a critical measurement and should define the full effect of zero-COVID and Russian sanctions. Keep an eye out for this.

Source: China National Bureau of Statistics, July 2022

China prices growth decelerates in July

Prices decelerated quickly in July.

The red bars charted below indicate that prices rose faster at the end of July compared to early July for only five items.

Given zero-COVID you’d almost expect to see all of them down. However, Soy is always a large import, and with the higher USD an element of imported inflation would explain the rise. And, given China’s pig herd was decimated during COVID, a pig price acceleration is no surprise.

There were some very small increases in the prices for lower calorific value pulverised, lump and better quality, but not for high quality thermal coal.

Regardless, price velocity is slowing and it’s the rate of change that’s important.

Chart utilises data from China National Bureau of Statistics, July 2022

Revenues and Profits of Chinese industrial enterprises stopped growing for the first time in 12 months

At the micro level, revenues and profits were flat month on month.

In other words, zero profit growth for China firms.

Again, the level doesn’t matter, it’s the rate of change that really matters and as of June there was zero profit growth.

Keep your eye on next month’s release, it will be critical.

Source: China National Bureau of Statistics.

Drilling down a bit further, profits for SOEs were up (unfair subsidisation?), but for foreign-invested enterprises and enterprises with investment from Hong Kong, Macao and Taiwan, profits decreased 13.9% and private enterprise profits decreased 3.3%.

But of even more interest was the total profit of the manufacturing industry was down 10.4% and the total profit of power, heat, gas and water production and supply industry was down a whopping 18.1% over a couple to a few weeks.

Two periods do not a trend make, but for how long will this continue in the world’s factory?

Contraction, recession and capital flight

With the U.S. seeking to defeat inflation with interest rate hikes (as is Canada, Australia, the UK, etc, etc) and China seeking to slay the virus (and perhaps production/inflation) with lockdown, the global economy is contracting between two converging bookends.

Europe is impotent and while it raised rates it also re-committed to QE Infinity via its new transmission protection instrument (aka, big bond buying bazooka) and Japan committed to yield curve control months ago, effectively pushing capital offshore to a higher yielding USD.

We now have most western economies no longer on pre-set normalisations, one big one actively buying all available 5 year bonds, possibly the largest economy (in aggregate) saying it will buy shed loads of bonds if needed, plus a short squeeze in commodities and inputs courtesy of a despotic Russian terrorist holding the world to ransom while China continues with zero-COVID.

It’s quite likely that a number of economies and markets are still to break - and when enough have broken, key central banks will have to pause their interest rate cycles and risk markets will party, no?

If that happens and assuming zero-COVID in China and Russian mercantilism remain, try not to make the mistake of thinking that the real economy is growing just because the punchbowl or some ludicrous fiscal spending package comes out again, because it’s not.

Check out the industrial production index in the U.S. What reopening?

Source: NLC chart using FRED data points.

You can also check out hundreds of consumer sentiment and PMI charts, with the ISM’s PMI for the U.S. likely to cross the 50% line (signalling contraction) either this or next month.

The word recession is often misused and it’s unhelpful. But what is helpful to know is that the world is in a contractionary phase of the global business cycle, capital is flighting to the U.S. dollar, interest rate normalisation is no loner on a set course and remains subject to political persuasion, Ukraine is far from being settled, and there’s a Russia/zero-COVID fuelled short squeeze still affecting food and fuel commodities with increasing swings and volatility in the price action.

Summary

The world economy is in definite contraction while still being fuelled by $300 trillion plus in debt - and not productivity.

Add to that a rising cost of capital and strong USD, and many net importer nations squeezed of fuel, food and staples are going to get hammered and barbequed.

In Australia, the RBA has gone ‘data dependent” and is not on a pre-set course when it comes to further interest rate decisions after today’s 50 basis point hike. It’s a reactionary body now, just like the Fed and ECB, and I believe these are the first signs of a coming pivot, ETA unknown.

Like I said above, the dragon eats >70% of the world’s iron ore, 60% of all of the nickel, 42% of global copper supply and 25% of global energy and is the world’s largest producer and consumer of aluminium.

So, in this very chameleon moment when few things are what they appear to be, keep your eye on the dragon’s cough and make your business, financial and investment decisions carefully.

Mike

Dragon grounded by virus while West targets inflation, North suffers