News out of China is opaque; often altered, editorialized, or outright censored. It is rare to receive a straightforward assessment, based in fact, irrespective of the congruence with the China governmental aims. Zhou Xiaochuan (ZX) is a maverick Central Bank governor, versed in global economics, and financial markets. ZX is a reformer, pushing to open China’s financial markets and currency regime in order to achieve longer-term economic goals. Over the past couple of years, news that ZX would be replaced caused China stock market rallies, as more accommodative, short-term oriented governors were rumored to take his place. For years, China deferred near-term pain, always attempting to maximize short-term growth. The push-out game is now over.
The FT recently ran a story crediting ZX with selling the need to devalue the renminbi to party leaders. This policy action is correct and was likely inevitable. ZX ranks as one of the most important government leaders in all of China, rivaling Xi Jinping, in terms of market influence. On Friday, it was reported by Bloomberg, that ZX is forthright about the China “bubble bursting”. This is one of the clearest assessments on China markets, and indictments of the China growth miracle. When a bubble bursts, you don’t go right back to the old price level. The new level of lower prices is more reflective of reality than the past level of bubble prices. Oftentimes, it will take years, or decades, before new highs are achieved, generally after a complete reset, and structural overhaul. With all the intervention to prop up the China stock market, ahead of the 70th anniversary parade for Japan’s WWII defeat, the market still has a large degree to fall, to fully pop the bubble.
Another example of China “short-termism” can be seen with what happened to the sky in Beijing in the days leading up to the parade, and in the subsequent 24-hours.
Turbulence in global financial markets is here to stay until the following items are resolved/reset:
- Consensus view emerges that China is in recession
- China’s stock market crashes to pre-bubble levels
- China fully implements the policies needed to combat a recession; primarily significant depreciation in the yuan
- EM currencies devalue to a) reflect the China recession and b) for EM export nations to competitively match the level of China depreciation
- The US Fed needs to start hiking interest rates
- The US stock market needs to approach bear market territory (call it S&P 1,800-1,820) to reflect the extent to which the above factors weigh on US corporate earnings