China’s spectacular reopening amidst skyrocketing cases has puzzled many of us. The selective reporting of the western media doesn’t make things easier. Hence, we pay close attention to folks like Louis-Vincent Gave of Gavekal research, someone who has eyes and ears on the ground and is also known to speaking his mind. Here’s an interview with the Market where he talks about the impending consumption boom in China as a result of the reopening yet with supply breakdowns as Covid infections spiral – a recipe for inflation to hold up. Yet, he reckons the Fed is done with tightening thanks to its responsibility to keep the US government funded and how all of this is likely to create a boom in Emerging Markets.
What should we expect from the reopening?
“First, we’ll get a surge in consumption. You have to remember that it’s not three months, but three years of pent-up demand. Going into the pandemic, households in China had about 8 to 9 trillion RMB in cash in their bank accounts. Today that number is 15.5 trillion. It has gone up more than 50%, because for three years all that people did was work and go home. They are more cashed up than ever before. Plus, mortgage rates have just dropped 150 basis points. In the West, when people came out of the lockdown and saw that interest rates had fallen by 50 or 75 basis points, they decided to buy a new apartment or a new BMW. There was a surge of consumption driven by low interest rates. Well, in China, mortgage rates are at record lows today. The same goes for car loans. How big is the release of pent-up demand in China going to be? It’s going to be enormous.”
What about Covid infections caused by the reopening?
“During the first few months, everybody will get Covid. Remember the summer of 2021, when there were hundreds of cancelled flights in the US every day, because the pilots called in sick? When we saw 100 container ships sitting outside the Los Angeles ports, because there were no truck drivers? This is where China is heading: Everybody will call in sick. If you are Apple, and if your business model depends on 100’000 workers showing up at your factory, you will see a shortage of workers in the next six months. Most of the industrial workforce in China still lives in corporate dormitories where the virus will run rampant. So the next six to nine months are going to be all about a massive increase in Chinese demand on the one hand, and massive production dislocations on the other.”
Despite inflationary forces holding up, why does he think the Fed is done tightening?
“Most people think of the Fed as having two mandates: price stability and employment. But it actually has a third mandate that nobody ever talks about: Making sure the Treasury market stays functional to make sure the US government gets funded. Which one of these three is the most important? If push comes to shove, they won’t be able to make a choice. The Fed will have to keep the government funded. Looking at the numbers, you see that the interest expense on US debt over the next couple years, with the rollovers that need to happen, will rise from $900 billion to $1.4 trillion per year. Spending for Social Security is roughly $2.2 trillion per year. Tax proceeds in a non-recession year are about $4 trillion. So, rather soon, Social Security and interest expenses alone will basically make up all of the tax receipts. There will come a point where the Fed just can’t raise interest rates further. They need to keep the government on the road, and without printing money, without lower interest rates, the Treasury market will melt down.”
Why is he bullish on Emerging markets?
“What I find fascinating in 2022 is that we have seen outperformance from Brazil, India, Indonesia, Mexico, or South Africa – from every major EM ex China. And this applies both to bonds and equities. This is highly unusual during a Fed tightening cycle. EM were outperforming when they were facing terrible macro headwinds, now these headwinds are turning into tailwinds: China is reopening, the dollar is rolling over, and the Fed is pretty much done tightening. I think emerging markets are going to rip. They’re a hugely underowned asset class.”
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