Rabobank: The Battle That Actually Matters Is Elsewhere

By Michael Every of Rabobank

“The operation was a complete success…”

“…but unfortunately the patient died”, as the old joke goes. The origins of the linked phrase ‘Pyrrhic victory’ dates all the way back to antiquity, when in 279BC Pyrrhus of Epirus won a battle against Rome that so decimated his forces he declared: “Ne ego si iterum eodem modo vicero, sine ullo milite Epirum revertar” (If I achieve such a victory again, I shall return to Epirus without any soldier.)

I mention this today not just because the White House is publicly rallying round what US Allies see as a logistically-shambolic retreat from Afghanistan, where “getting 90% out” also means “leaving 10% behind”. Indeed, if the US retreat generates a “We can ill afford another Klendathu” moment within the DC foreign policy Blob, who is to say that history won’t see it as a genuine pivot point?

As President Biden noted in a public address yesterday defending his decision: “As we turn the page on the foreign policy that has guided our nation for the last two decades we have got to learn from our mistakes. To me, there are two that are paramount; first, we set missions with clear, achievable goals, not ones we will never reach, and, second, we will stay clearly focused on the fundamental national security interest of the United States of America.” Of course, he has already made clear the other condition is the US will only fight for those who will fight with it – and I cannot emphasize enough what a sea-change in the global security architecture this implies. (Or how much further some say the US will have to shift policy –in directions allies, non-allies, and markets alike will find deeply unpleasant– if it truly wishes to act in its long-run national security interests.)

No, I mentioned Pyrrhus because all around us we see similar ‘victories’.

“We have beaten Covid with vaccines!” – Oops, Delta! Now we need three shots, not two. Until that doesn’t work either. And yet parts of the world still haven’t had one shot yet.

“We have economic recovery!” – As China’s services PMI slumps to 47.5, with the new orders index tumbling to a lower level than during the GFC, for example; and as US consumer confidence plunges from 129.1 to 113.8 in a month, and expectations from 108.4 to 91.4.

“We have beaten inflation!” – Meaning we have beaten demand-pull inflation, which still leaves us cost-push inflation and falling real wages, and so a collapse in consumer confidence.

“It’s time to taper!” – Say both FOMC members and ECB members, when we have no sign of any Building Back Better being done anywhere except in China, where it comes in a “profoundly revolutionary” wrapper. US stocks went down all of 0.1% yesterday, which was apparently worth mentioning for some press; and bond yields fluctuated on the hilarious notion that a major central bank may actually taper.

Meanwhile, as the US is now saying in a different policy dimension, the battle that actually matters is elsewhere. In particular, we are getting more details on China’s “profound revolution”:

First, a threat to shut down e-commerce platforms caught selling fake goods; second, shutting down the American Chamber of Commerce in Chengdu “because reasons”. But, more concretely, official policy to limit urban rent increases to 5% annually along with an announcement that land and home prices “will be stabilized”, while rumors of a potential property tax whirl. This is very, very big. Imagine the same in the US, UK, Australia, NZ, or Europe. It’s just as important in China.

At the same time, Bloomberg carries an article looking at the province of Zhejiang (population 65m) and its existing pilot experiment with Common Prosperity. What is being seen there is not tax-and-spend or a welfare state: rather it is forcing capital to flow to areas previously starved of it and huge efforts to bring down living costs. Specifically:

• Targeting inequality (of intra-provincial GDP per capita) directly;
• Aiming to increase the labour share of GDP to more than 50% (vs. the World Bank 2020 national household share of GDP estimate of 38%, which is a huge ask for obvious reasons – which GDP sector will be dropping by 12 percentage points given we also know there won’t be a swing allowed to a negative-net-exports trade deficit?);
• More urbanisation;
• Property taxes (on private housing) and building state-owned rental properties (social housing);
• Letting people without official hukou residence access state services, which is a genuine revolution;
• More spending on social services – and “donations” from local billionaires worth $236bn;
• Lower cost business loans for favoured sectors, including manufacturing and tourism; and
• SOEs building more infrastructure, even if it generates low returns.

As such, we get a picture of potentially higher growth, but lower returns; less luxury and more mass-market; and far more regulation. Which sounds like something Western markets don’t understand and won’t like. They prefer lower growth and higher returns; less mass-market and more “premiumisation”; and far less regulation.

Also important, the Chinese Communist Party has also just announced that it will hold a key plenum in November – though what major policy changes this portends against the current backdrop remains to be seen. One would posit it is unlikely to be small beer.

But of course, Western markets and politicians stressing the fragility of Western liberal democracy and the ‘rules-based international order’ don’t need to be concerned by policy shifts from Beijing, or it showing how Building Back Better actually needs to be done in practice, not rhetoric, such as via targeting inequality and labor share of GDP, social housing and rent controls. After all, they still have QE (for now), that marvelous magical cure for all social and economic ills! It’s a monetary operation carried out every month that is always a success for markets and asset prices, even if the political-economy patient dies. “Si talem victoriam iterum consequor, sine ulla societate ad normales revertar.”

Tellingly, Kiwi house prices were up 27% y/y today, when the RBNZ just left rates on hold, surprising markets, despite now having a house-price mandate, and Australia’s Q2 GDP came in at 0.7% q/q vs. 0.4% expected despite everyone locked down at home, while CoreLogic house prices were up 1.5% m/m, so 18% y/y annualized. Marvellous and magical once again.