China’s tough policy choices

The Buttonwood column in The Economist had this to say about the recovery in metal prices (before the most recent risk-off episode):

A pattern in markets is that a lot happens by rote. China’s response to a weak economy is to build; investors’ response to the Fed’s easing is to buy stocks; the algorithms’ response to a weaker dollar is to buy commodities. Higher prices beget higher prices. The sceptics, the too-sooners, note that this also works in reverse. Quite so. But the momentum is now with the believers.

Even as the copper/gold ratio recovers, there are reasons to be skeptical. As a reminder, this ratio is a useful indicator of global cyclicality. Both copper and gold are commodities, and respond to hard asset inflationary pressures. Copper has more industrial uses, and therefore the ratio can be a way of filtering out the hard asset inflation element out of copper prices.


There is a speculative element to the rise in metal prices, too. Buying or selling copper futures is a popular way to express a view about the world economy. Indeed copper can be all about belief, says Max Layton of Citigroup, a bank. Many of the bets laid on it are by trading algorithms, which mechanically respond to financial signals that have worked well in the past. The dollar, which has fallen by 6% against a basket of currencies since March, is usually part of the semaphore. A weaker dollar allows for easier terms of finance in emerging markets. Anything that helps emerging-market economies is generally good for commodity prices. So the algorithms buy.

The complex of price changes becomes self-reinforcing. Higher ore prices bring higher-cost producers back to the market. But their profit margins are then squeezed as their home currency appreciates, because that raises the cost of labour in dollars, in which commodities are priced. To restore margins, prices must go up. Moreover, marginal costs rise when the prices of steel (used for mining parts) and oil (used for energy and chemicals) go up. These higher costs push up prices further, says Mr Layton.

What policy choices does China have to revive its economy?

China’s challenges

From a long-term perspective, China has a demographic problem. Its population is aging rapidly. The engine of its growth miracle, which was initially based on the widespread availability of cheap labor, is starting to sputter.


The second problem is debt. Its debt burden has grown to gargantuan levels, and its debt to GDP ratio has plateaued at levels where other countries have experienced crises.


These headwinds are well known, and Beijing has worked to address these issues for some time. Then policy makers got blindsided by COVID-19, and the authorities chose to respond by putting the entire country into quarantine and shutting the economy down. Now that activity is restarting, growth has become even more unbalanced. Industrial activity has revived, but consumers continue to struggle. Just as consumer activity appeared to rebound, it fell again.


China’s policy makers chose to restart the economy by focusing on production, whose growth potential depends mainly on exports. The pandemic has spread around the world, and the ensuing shutdowns have cratered demand. If global demand is weak, China’s export led strategy has limited upside potential.

What can policy makers do?

Difficult choices

One option is to double down on the export strategy through devaluation. There are two problems with a devaluation strategy. First, it would invite capital flight, and raise doubts about the RMB as a stable reserve currency. As well, it is unclear whether devaluation confers any net growth benefits. The policy is just a subsidy for exporters at the expense of domestic producers and the Chinese household sector. It would also run counter to Beijing’s objective of rebalancing growth towards consumers.

The PBOC’s exchange rate policy recently shifted to a currency basket. Since that shift, the Yuan has been remarkably stable against its benchmark basket, which is a sign that China does not want to pursue the devaluation path. Nevertheless, the volatility of its exchange rate against the USD has increased, but that’s a USD effect, not a CNY policy effect.


The combination of USDCNY volatility and the collapse of China’s imports from the US under the Phase One trade deal has the potential to raise trade friction with Washington.

Wolf Warrior diplomacy

What does a government do when its economy is sputtering and it can’t find a solution? One of the usual approaches is to adopt a nationalist approach in its foreign policy as a way of distracting from problems at home. Indeed, China has pivoted to “wolf warrior” diplomacy to defend its interest. Minxin Pei, Professor of Government at Claremont McKenna College, explains in a Project Syndicate essay:

For example, in mid-March, the foreign ministry’s newly appointed deputy spokesman, Zhao Lijian, promoted a conspiracy theory alleging that the US military brought the novel coronavirus to Wuhan, the pandemic’s first epicenter.

Similarly, in early April, the Chinese ambassador to France posted a series of anonymous articles on his embassy’s website falsely claiming that the virus’s elderly victims were being left alone to die in the country. Later that month, after Australia joined the United States in calling for an international investigation into the pandemic’s origins, the Chinese envoy in Canberra quickly threatened boycotts and sanctions.

In addition, Beijing has taken steps to assert more control over Hong Kong’s affairs, which has rankled many Western capitals. The China-India conflict is heating up. There are reports that Chinese troops have encroached on the Line of Control (LOC) between the two countries, and established positions and artillery emplacements on the Indian side of the LOC.

A Bloomberg article suggests that China actually prefers a Trump win in November despite his “tough on China” reputation as Chinese foreign policy as a signal of prioritizing geopolitical over trade objectives:

Interviews with nine current and former Chinese officials point to a shift in sentiment in favor of the sitting president, even though he has spent much of the past four years blaming Beijing for everything from U.S. trade imbalances to Covid-19. The chief reason? A belief that the benefit of the erosion of America’s postwar alliance network would outweigh any damage to China from continued trade disputes and geopolitical instability…

“If Biden is elected, I think this could be more dangerous for China, because he will work with allies to target China, whereas Trump is destroying U.S. alliances,” said Zhou Xiaoming, a former Chinese trade negotiator and former deputy representative in Geneva. Four current officials echoed that sentiment, saying many in the Chinese government believed a Trump victory could help Beijing by weakening what they saw as Washington’s greatest asset for checking China’s widening influence.


Confrontations ahead?

Here is the risk for the markets. It’s not just Chinese policy makers who are subject to pressures in their own country. In the US, Trump’s poll numbers have been sinking in the past few weeks. Even if you don’t believe the polls, market based indicators, such as the odds on PredictIt of a Trump win has also been falling. In addition, the stock market has been wobbly in the last few days.


So far, Washington has largely held its fire over the failure of China’s Phase One commitments and the Hong Kong situation. In light of Trump’s deteriorating poll figures, there will be a temptation to pivot to a similar nationalist political response.


Our “trade war” factor is showing very little stress, but the potential for a spike is high. The markets will not respond well to another shock like this, especially when they are already burdened with COVID-19 related uncertainty.


71 thoughts on “China’s tough policy choices

  1. I seriously doubt that China would prefer Trump over Biden. Biden just said a few months ago that China isn’t a problem. Besides, he owes them a personal Billion Dollar favor. China would love to have to negotiate with Joe.

  2. Hulbert’s sentiment index now ~26 points below recent highs. He did note that the decline on Friday (despite a recovery in the SPX) was probably a delayed reaction to Thursday’s selloff. The further decline today (in the face of another advance in the indexes) indicates skepticism in the recovery. A modest tailwind in my opinion.

      1. Thanks, Sanjay. This market continues to confound traders – and most of the unexpected price movements seem to occur outside regular trading hours.

    1. There was a spike up right at 1 PM CDT on volume. It lasted about 15-30 minutes. I didn’t see what news came out at 1.

  3. Cam – Wondering if you have a take on this:

    Puru Saxena

    ‘The previous two *secular* bull markets ended when $SPX earnings yield was approximately 65% of the Fed Funds Rate.

    ‘$SPX earnings yield is currently multiples higher than the Fed Funds Rate.’

    1. He is very bullish. Here are some other quotes:

      “During a bull market, especially one which is powered by ZIRP and QE, growth stocks will probably do well and pullbacks/fear should be bought.”

      “We are likely in the early stages of a bull market.”

      “Pullbacks and volatility are normal – if history is any guide, this bull market should run for several years.”

    2. Adequate Ryan
      Replying to
      So you’re saying if we make Fed Funds Rate 0% the bull market will never end?

      1. I guess the relationship does not work if the Fed Funds rate approaches zero (or negative).

        I won’t take Puru’s statement literally.

      1. So, based on Urban Carmel’s post, PE ratio circa late 2014 when he published his missive was 25 (see first picture) which was higher than where it is today.
        Market has rallied significantly since 11/2014 (say around 50%).
        Does PE ratio accurately reflect if markets are expensive or not? Let us discount the 10 year treasury rate back then and now (since rates do not matter).
        Why was market not expensive then, but it is today, based on higher PE ratio then versus now?


    I like Schwab commentaries. In this one, they are talking about a W shaped stock market recovery, with the initial V of the W being what we are seeing. That said, they have also discussed what is likely to happen in the US economy going forward. They are predicting an economic transition from a consumer/services driven to an investment/capital driven model going forward. The capital driven market has been discussed as bringing supply chains back to the US. This will lead to job losses in certain segments at the expense of others (see what they are saying).
    Joyce, hang in there. There is likely to be a decent pull back here coming, when all is said and done. Wait for the Q2 earnings, which are a month away, after which reality will likely set in. Until then, hopefully the party continues (I have written this earlier).

    1. DV, Liz Ann is expecting a “rolling W” type of recovery. I assume that means multiple Vs. Did she give any rationale for those expectations? Thanks!


    I like Schwab commentaries. In this one, they are talking about a W shaped stock market recovery, with the initial V of the W being what we are seeing. That said, they have also discussed what is likely to happen in the US economy going forward. They are predicting an economic transition from a consumer/services driven to an investment/capital driven model going forward. The capital driven market has been discussed as bringing supply chains back to the US. This will lead to job losses in certain segments at the expense of others (see what they are saying).
    Joyce, hang in there. There is likely to be a decent pull back here coming, when all is said and done. Wait for the Q2 earnings, which are a month away, after which reality will likely set in. Until then, hopefully the party continues (I have written this earlier).
    There is a wealth of insight they have shared here.

    1. Cornerstone Macro is also arguing for the return of manufacturing / industrials from China/abroad.

      How realistic is that? The private businesses are answerable to their shareholders. What incentives do they have to take the risk and invest in relocating their supply-chains back to the US, not to mention the risk of the loss of Chinese market?

      It won’t be easy. In technology, the whole ecosystem, the business expertise, the human capital, and the operations know-how reside in China. You need to forklift the whole lego set if you don’t want to break the supply-chain.

      I wonder if someone has done a thorough study on on-shoring the supply-chain.

    1. Yes, the elixir is working but for long? I suppose if the goal is to coax out cash into stock market, it is probably working.

  6. Nice upside follow-through. The minus 310-point pullback in the SPX/ES may have been enough to launch the next leg higher.

  7. Joyce- Hope you went at least 50% long yesterday. The SPX is poised to reverse all of last Thursday’s decline.

    1. I have no idea how to trade the twists and turns of the 2020 market, which is why I think a portfolio approach (at least until the fog lifts) will work. Sure, there’s always downside risk – but we’re now coming out of a -10% pullback. There are traders (Landry may be one of them) who might actually wait for a break up above 319 as a trigger to go long. The entire concept of having missed out is something you need to discard. The investor or trader who captures 100% of every move doesn’t exist – it’s more of a head trip.

    2. RX, I think we may now be in Cam’s sideways market with swings between S&P 3000 and 3300 until we can put the coronavirus in the rearview mirror.

      1. OK, thanks Wally. If it begins to work out that way, I may switch to trading the range – right now, it’s just too easy to get whipsawed.

  8. Powell just said parts of the economy will struggle to come back because of social distancing. That is being attributed to the current drop to new daily lows.

    1. It doesn’t take much, does it. I would have guessed the bulls would try to blitz prices to 317. Here we are at 311.

      1. Just a few words. It did bounce off yesterday’s high and now we are in the middle of today’s range.

      2. I like the fact that SPY retraced to 307.67, which probably ran a few stops set by this morning’s buyers. Coupled with the -10% pullback over the past few days, most stocks now in stronger hands.

        Still think we need a week of more grinding before a durable liftoff.


    I am posting a slew of tweets. There is a lot of cross currents in these, some actual data from Liz Ann Saunders, but also technicals from Wally Deemer and a warning “this will not end well”.
    Sven Henrich’s goes to ask the question we are not supposed to ask in America (like Lord Voldermort, whose name we could not say). Honestly, what we are seeing here is a demise of free markets. Sven Henrichs point is well taken.
    Zomby companies are flying, bankrupt companies are issuing stocks.
    The whole thing is quite mind boggling. Ken’s warning has been prescient, but the music is still playing, for now. I am waiting till earnings numbers next month.

    1. This notice is for everyone: If you post a comment with more than one link, the system holds it as possible spam and I need to approve it.

      If you post any comments like that please email me and I will approve. Otherwise it sits in the queue until I notice it, which could take a couple of days.

    2. Relax and take a thirty-minute walk out in the sun. Then come back and see if you feel the same way about the ‘demise of free markets.’

      Do you realize that 95% of investors spend probably less than a few hours a year on their portfolios?

    3. The only concern I have about that is that the Fed is certainly putting a floor under markets and we are seeing incredible amounts of money come from the Fed and the Legislative branch to support the economy. If there is no risk of a downside crash is there also no opportunity of a bull market?

      Removing the risk of a crash is also removing the opportunity to buy at bargain basement prices. But does it also remove the ability of the markets to flourish? Possibly.

  10. Watching 3200, last Thursday, from where we gapped down to 3000 next day. I suppose it would take prices higher than 3200 to undo the Reversal? I suppose today, @ 3130, we have still not reversed the Island reversal? Please explain. Thanks.

  11. Well, out here in central California…covid may not peak until February ,by which time we will be short multiples of ventilators for months. Wife works in a hospital and the icus are overrun cases are spiking and most people at Walmart don’t wear masks while shopping….maybe lockdowns won’t restart, but I would not bet on a fast recovery. Of course maybe the markets will be irrational for another few years.
    Took a look at the copper/gold chart for 50 years…there was a big drop in the 70s because of Nixon in 71, but after the drops also marked drops in the market like 2002 and 2008. Of course if gold shoots up the ratio can go down, but we are at support from 1980 and then it is new lows…either copper needs to rip gold a new one or we are looking into an abyss.

    1. I just don’t understand why people don’t wear a mask when out and around people. Sure, they can be a bit warm in the summer but it just might save your life or a relative’s life.

      1. it is a no brainer…less droplets should equal less spread…whether it protects the wearer or not, it should protect the group. But it is a God given right to be stupid in what one does. The big question for 2020/2021 will be “who can we blame?”
        But look at the long term copper/gold chart.
        My sleeper stock of 2025 is NAK, because when we get the crash and everything goes down, including copper, maybe NAK can be bought for a dime. I think it is on another hype cycle and will go down eventually. Not getting it now, and maybe the bondholders will get it if they file for bankruptcy, but it is one to keep on the radar fwiw. I said 2025 to give time for a crash, and recovery and time so that one can see if the company survives. I did buy a call with 3 days of life for 5 cents because I think it gets pumped tomorrow….5 dollar table at the casino, one bet lol

        1. I once bought some options for pennies with a few days left and sold them for around 20 or 30 cents. I thought I had made a killing, but they went off the board around $10. I could have been wealthy and blew it!!!

    1. I would if I knew how to post a screenshot, only I don’t.
      It is impressive.
      Silver:gold is interesting also.
      We are at an all time low. The highs were 1980 courtesy of the hunt bros and 2011.
      Significant lows were in 73, 75, 82, 87,03, 08,15/16, and the big kahuna …now….
      Does this mean we are due for a massive collapse or an unbelievable bull based on helicopter money? Dunno.
      They want inflation to reduce all that debt’s value, maybe Covid is an excuse to flood the economy and reset the currencies.
      We have to see what the prices tell us, but I confess to being nervous about things.

      1. I’m always nervous about things.
        1. If the market is up and I’m in, I’m nervous it will crash.
        2. If it’s up and I’m out, I’m nervous it won’t let me in.
        3. If it’s down and I’m in, I’m nervous it will go down further.
        4. If it’s down and I’m out, I’m nervous it will take off without me.

  12. Another quiet move up after hours. I think the bulls take a shot at SPY 319 on Wednesday.

    1. A period of stagnation then a late year rally? That dirty dog. I was going to guess that.

        1. I remember that. It was just a few years before they started screaming the lyrics to new songs and you couldn’t understand the words any longer.

          1. That track does a a pretty good describing how I feel when being whipsawed by the market 🙂

            The SPX managed to breach the 3015 resistance level overnight. SPY 319 will be a tough advance, and may require another pullback before it succeeds. But then the 2020 market has been full of surprises.

  13. Buried in one of the later paragraphs of the article below is an interesting conjecture by the authors:

    ‘Labor’s share of GDP — long thought to have been an immutable constant — has fallen in recent years, and market power in both product and labor markets may be one reason. If the unemployment rate remains high in the coming years, the terms of trade between labor and capital will be pushed even further toward the latter, inverting the Black Death analogy and justifying the stock market’s optimism in the face of catastrophe.’

    1. Don’t forget the robots. The robots are coming in a big way in the next 20 years.

  14. I think the odds are high that we’re seeing the unfolding of a new bull market, one which has been initiated in the usual manner – ie, no one believes it’s the start of a new bull market.

    1. One which at least one market commentator will tells us six months from now was obvious to him/her at the time 🙂

    1. I think that is sort of normal as buyers look for stocks that haven’t participated yet.

Comments are closed.