By Michael Every of Rabobank
Guns 'N' Roses
COP26 is over and Bloomberg’s take is it “seals breakthrough climate deal after major compromises,” as Wall Street cannot says ESG without salivating. By contrast, COP president Sharma wept and apologized, and Greta Thunberg said “Blah blah blah.” Indeed, coal is not to be phased out but “phased down,” its longevity is ironically underlined by PM BoJo, who thought the summit was held in Edinburgh not Glasgow, proclaiming its “death knell”; the 1.5-degree Celsius target is not being met; and the can was kicked to COP27 in Egypt. The blame is being placed on India and China, but US coal is still 20% of its electricity generation, and Germany is hardly green. Then again, with energy prices surging due to a ‘green rush’, we already close to a global energy crisis, and a likely food-price crisis to follow ahead if fertilizer prices don’t decline.
Use Your Illusion, 1 and 2 (1991)
Today late US time, tomorrow Asian time, another key summit starts – between the US and Chinese leaders. This is not about trade; or Huawei; or ‘green’; or sunshine and roses. It is about guns. Market analysts will recoil, but a former high-level US diplomat writes in Foreign Affairs: “Although this coming summit cannot resolve, or even begin to resolve, issues such as the future of Taiwan, it does represent a chance for both leaders to re-establish some of the safeguards that can prevent these disputes from being decided by force…The US-Chinese relationship is in dire need of such diplomacy --particularly at high levels-- in order to stem a downward spiral that could lead to war.” A lot of tightly-held market illusions are riding on it.
On the economic side, Bastiat said, "If goods don’t cross borders, armies will." However, the inverse realpolitik argument heard in DC is now that if goods cross borders, armies don’t have to bother. Consider this weekend’s Guardian report that “Beijing urges US businesses to lobby against China-related bills in Congress” – bills for the US to mirror Chinese industrial policy, with Beijing threatening US firms with loss of access should this legislation pass; The Economist saying “China still steals commercial secrets for its own firms’ profits”; and the UK ambassador being accused of lobbying the cabinet for China.
Then there is the need to Build Back Better, which as Pettis and Klein underlined in ‘Trade Wars are Class Wars’ is actually all about the political-economy model. On which, see this long-read from Chinese intellectual Qin Hui, who argues we face a structural clash of economic systems as things stand, underlining the argument long echoed here that Western views of left vs. right no longer apply in a world economy centred on Chinese production. Ironically, when Bloomberg Opinion argues “Americans Need to Learn to Live More Like Europeans: Supply-chain shortages are constraining US consumers' endless appetite for buying whatever they want whenever they want. It's about time,” what it is actually implying is higher US savings, and so a swing from a trade deficit to a surplus…which would up-end the European and Chinese economic models it lauds, which are built on forcibly saving too much, via repressed demand, and exporting their excess production to the US directly and indirectly. I doubt the author grasps this – they are just echoing what they think they heard the White House say about inflation recently. In short, the Biden-Xi summit will find little common ground on the area the market is most concerned about – markets.
Chinese Democracy (2008)
For those who think the US-China tensions are not ideological, the Global Times also just stated in an op-ed that China is a “vigorous democracy,” while the West’s is ageing, and has developed an “efficient market economy” based on its political system, while the West is struggling. It concludes: “…The Chinese and Western democratic systems could learn from each other and carry out sound competition. Unfortunately, some political elites in the US and West stubbornly seek to turn the two systems into antagonistic relations. Then they will have to bear the long-term consequences of their actions. China will develop faster than them in the long run. After passing a critical point --it's doomed to appear in future-- the US and West's political confidence will be greatly shaken. Their unrealistic flattery of Western-style democracy will collapse.” So what is the ‘correct’ US/Biden response?
Over Taiwan, the binary is even starker. The Global Times elsewhere urges “the US not to be reckless on trade and mutual security issues, especially on the South China Sea and Taiwan question, as it cannot bear the response from China.” Yet the South China Morning Post says ‘US puts Taiwan in focus in countdown to Xi-Biden summit,’ quoting other Chinese analysts stating Beijing and Washington need to reach a new deal to prevent armed conflict. What deal, exactly? Yes, US language is shifting: “Cold War” was never in vogue, but “extreme competition” just became “stiff competition” according to US National Security Advisor Sullivan. Will it transmute to “sound competition”, when US military alliances in the region are stiffening? The Aussie defense minister just said Canberra would also defend Taiwan, and Japan has suggested the same.
Before the meeting we also saw a slew of key Chinese data that suggest its economy is struggling --if less than had been expected-- so there is again less tolerance for any US boat-rocking. New home prices dipped 0.3% m/m, showing an accelerating decline in this key sector; yet somehow retail sales were somehow 4.9% y/y vs. expectations of 3.7% (a price effect?); industrial production was 3.5% vs. a consensus of 3.0% y/y (an export effect); and fixed asset investment was 6.1% vs. 6.2% y/y YTD expected. Meanwhile, the plunge in the US Michigan consumer sentiment survey expectations index on Friday sent a similar message of serious trouble Stateside. In short, protocols to reduce tensions are welcome, and a common desire to deal with some joint problems is clear - but structural binaries on how to resolve them at root remain clearer. So do fat tail risks markets don’t want to see. Expect November Rain?
The Spaghetti Incident? (1993)
On which note, the crisis on the EU’s eastern border grows. Russia/Belarus are orchestrating the destabilization of Bosnia, an EU gas-price spike, a migration/border crisis, and the renewed threat of war with Ukraine (the rumor being Moscow may seize control of at least the Sea of Azov, which would impact on global wheat exports at a time when prices are already skyrocketing). Gas aside, this may not be registering in the west of the EU, but that is precisely why Russia is doing it: to expose that the EU is divided, and NATO looks unwilling to act. Because Russian gas flows across borders, à la Bastiat, either its army does not have to, or its army is able to flow as well, with “strategic autonomy” Paris and “Merkelcantilist” Berlin both saying “Whatchagonnado?” By contrast, the UK, ever eager for a distraction from a litany of corruption scandals, is sending token forces to support Poland, and the Guardian quotes the head of the UK armed forces stating the country needs to be ready for war with Russia: bomb back better?
In short, we are starting to see serious volatility in some parts of the global financial markets: and, aside from central-bankery, much more is certain to come if you look at the real-world events unfolding as a direct result of four decades of people endlessly saying, “because markets.”