The China Syndrome
Do you remember the 1979 Jane Fonda and Jack Lemmon movie, The China Syndrome? It was about a cover-up at a nuclear power facility that was malfunctioning and creating a nuclear hazard. I’m not sure how much we Americans have thought about either nuclear disaster or even China as a risk to our lifestyle since then, but we are about to be faced with a whole new version of China risk than we have ever witnessed before. As most of us realize these days, despite what we see happening on the battlegrounds of Ukraine and Gaza, the front lines of today’s most impactful conflicts takes place in the marketplace. I would argue that one of the biggest threats to our lifestyle here in the Unites States is inflation, but it may not be for the reasons we all think.
I just read a fascinating Economist article about what Xi’s China is doing to prop up its faltering economy. After 25 years of rapidly expanding internal consumer demand in China, based heavily on the 9%+ GDP growth rates they have enjoyed, and as that growth has fallen to 5% and is heading, based on World Bank estimates, to about 2% (lower than growth rates in the weaker days of the U.S. economy), Xi has a new plan. China has gone back 25 years to the original China Shock at the turn of the Millennium and decided that they have to manufacture and export their way to a recovery from this downward spiral. You might think that is a tough row to hoe with a world that has been successfully working to repatriate manufacturing as part of the growing nationalism and the strategic national security imperatives that the new digitized, AI-driven world increasingly demands. But the truth is that as the developed world has stopped worrying about deflation, with zero and sub-zero interest rates over ten plus years, we have very quickly refocused on rising rates and the rebirth of inflation. Once inflation strikes, as we’ve seen in the national reaction to the wonders of Bidenomics, we all want price reductions, not just reduced inflation. And that’s a hard thing to materialize. Well, one of the ways it can materialize is through cheap, state-subsidized, Chinese manufacturing that is about to flood the world markets in a vast array of manufactured products. And the thing about Chinese products is that the extent of state involvement and subsidy makes it very hard to unwind for tariff and import protection purposes…and even harder to snub our noses at when we can palpably feel the positive impact on our budgets.
And there is the real rub. China will be handing us all a disinflation solution that we think we all want and need. Let’s face it, who among us does not like the fact that we can buy the biggest flat-screen TVs for what far inferior and smaller TVs cost us just a few years ago? We may all want to buy-American, but we have already proven that whether it is Japanese, Korean or Chinese goods, we are a sucker for low-cost manufactured goods and if China sells them, we are likely to buy them and be happy about it. Whoever is the next President will get a cost of living reduction, compliments of China manufacturing. As good as that initially seems, the Economist calls that a second China Shock, the impact of which we cannot fully fathom yet because let’s face it, China has far deeper pockets than most of us realize. That, and the thing we know about autocracies, is that they will spend what it takes to keep their people thinking that they are good at promoting national growth as part of the justification for keeping the autocrats in power as long as possible, which is often the secret highest priority in countries like China.
The places and ways in which we will see these things come at us include things like solar panels, solar batteries (remember, China owns the rare earths trove), and, by extension, the EV auto and truck markets. Don’t be surprised to see the next generation of AI-based tech products coming out of China. With what we are seeing with Nvidia’s stock price, you can be sure that the margins are attractive enough to spur the Chinese to either innovate or steal their own version of the latest AI technology in a way that the likes of U.S. regulators will be well behind on blocking before they get a foothold and our hearts and minds are too far gone to retrieve. You haven’t seen TikTok go away, have you? It’s the same force of consumer nature at work.
We rightly spend a lot of time thinking about and worrying about Ukraine and Gaza and the wars underway there. The former is all about Russia and Putin’s aggressions and flailings to stay in power by creating a national wartime emergency. It so happens that Ukraine is fighting back effectively enough to increasingly deplete the Russian arsenal and generally sap the Russian economy. That is, overall, a good thing for the world at large because it galvanizes NATO, as reflected in Finland and Sweden finally signing up and the war testing the resolve of Europe to both stand strong against Russia and also stand united by bringing less committed players like Hungary and Turkey back into line with the common EU outlook. As for Gaza, we see a similar situation with Netanyahu, who while not nearly as demonic as Putin, has his own demons at work in the form of the Israeli ultra-orthodox right wing, and has his own need to stay in power to avoid potential incarceration. It is clearer and clearer by the day that the toll being taken on the Palestinians (now over 30,000 deaths in Gaza alone and a destroyed cityscape and put-upon citizenry) is costing Israel its support from the EU and even increasingly the U.S. The situation has all but assured a common voice for a two-state solution following hostilities. Meanwhile, the action on the Hamas/Hezbollah/Huthi front has served to keep the Iranian keg more or less in check while the western world keeps its sidewise glare on the Ayatollahs and their next moves. But all that is still a lot of distraction from the main event for the world which is all about the headlines that involve China. Russia and Iran are bit players compared to China and while we can all live without Russia and Iran (even the EU is learning how to live with their oil and gas from either locale), it is unclear if we and the reset of the western world (not to mention the far eastern world) can live without China.
China still holds almost $1 trillion of U.S. debt and while exports from China to the U.S. stand at $600 billion of their total $3.7 trillion in total global exports. Those numbers are now going to go up dramatically and China has the wherewithal to make it happen while we do not have the lifestyle backbone to not take the bait and swallow the cheap goods. I am not saying that we should stop importing from China, nor that it is a bad thing that China wants to pull up its economic socks by growing their manufacturing once again, but I am saying that there is always a price to be paid at some point in doing all of this. China will accumulate more U.S. debt and we will be more and more beholding to China for both controlling our inflationary tendencies and supplying our deficit gap-filling needs. At some point we will have to reckon with the China Syndrome and figure out how to be comfortable with where we are with our big brother to the west.