China’s ‘Minsky Moment’ and an inevitable second referendum

China’s slowdown

Let’s start with China today because yesterday the Chinese released their worst growth figures in 28 years. The 6.4% growth number was expected. Even so, the problems are large. Here’s how Reuters described it yesterday:

China’s economy cooled in the fourth quarter under pressure from faltering domestic demand and bruising U.S. tariffs, dragging 2018 growth to the lowest level in nearly three decades and pressuring Beijing to roll out more stimulus to avert a sharper slowdown.

Growing signs of weakness in China — which has generated nearly a third of global growth in recent years — are fueling anxiety about risks to the world economy and are weighing on profits for firms ranging from Apple to big carmakers.

Policymakers have pledged more support this year to reduce the risk of massive job losses, but have ruled out a “flood” of stimulus like that which Beijing has relied on in the past, which quickly juiced growth rates but left a mountain of debt.

China’s Minsky Moment

Now I don’t like the term ‘Minsky Moment’, but that’s how Ken Rogoff  is describing what could happen if that Chinese debt mountain becomes unsustainable. Here’s how Ambrose Evans-Pritchard put Rogoff’s comments yesterday:

Harvard professor Ken Rogoff said the key policy instruments of the Communist Party are losing traction and the country has exhausted its credit-driven growth model.

This is rapidly becoming the greatest single threat to the global financial system.

“People have this stupefying belief that China is different from everywhere else and can grow to the moon,” said Professor Rogoff, a former chief economist at the International Monetary Fund.

“China can’t just keep creating credit. They are in a serious growth recession and the trade war is kicking them on the way down,” he told the Telegraph, speaking before the World Economic Forum in Davos.

“There will have to be a de facto nationalisation of large parts of the economy. I fear this really could be ‘it’ at last and they are going to have their own kind of Minsky Moment,” he said.

This refers to the financial instability hypothesis of Hyman Minsky. It is when a seemingly unstoppable debt bubble suddenly collapses under its own weight in a cascade of falling asset and property prices. The authorities can cushion the crash but they cannot escape the brutal mechanics of reversion.

My China summary and the IMF forecast

So that’s the worry here. It’s not that China is slowing. That slowing has been expected. And it’s not even that Chinese authorities will not inject massive stimulus to juice growth again. They have already said they won’t. The worry is that when the Chinese Communist Party do try and cushion the fall, they won’t be able to. And China’s fall then becomes the world’s fall.

Just yesterday, the IMF lowered global growth forecasts for both 2019 and 2020.

In its second downgrade in three months, the global lender also cited a bigger-than-expected slowdown in China’s economy and a possible “No Deal” Brexit as risks to its outlook, saying these could worsen market turbulence in financial markets.

The IMF predicted the global economy to grow at 3.5 percent in 2019 and 3.6 percent in 2020, down 0.2 and 0.1 percentage point respectively from last October’s forecasts.

The new forecasts, released on the eve of this week’s gathering of world leaders and business executives in the Swiss ski resort of Davos, show that policymakers may need to come up with plans to deal with an end to years of solid global growth.

“After two years of solid expansion, the world economy is growing more slowly than expected and risks are rising,” IMF Managing Director Christine Lagarde told a briefing.

“Does that mean a global recession is around the corner? No. But the risk of a sharper decline in global growth has certainly increased,” she said, urging policymakers to be ready for a “serious slowdown” by boosting their economies’ resilience to risks.

The second threat to growth is Brexit

Don’t let Lagarde’s measured language fool you. She is worried about a global recession, because everyone else is too. And the IMF mentions two big threats China and Brexit. So let’s talk about that second issue here as well.

I have been saying for weeks that Brexit was likely to be delayed, at a minimum because of the Irish backstop. Now, everyone is fast coming to the same conclusion. Talk of Brexit delay’s inevitability is everywhere. See former Conservative Party leader William Hague, for example:

There was much jubilation last week among the crowds outside the Houses of Parliament when Theresa May’s deal went down to a record-breaking defeat. Yet we are likely to look back on that moment in future years as a calamitous one for British democracy.

At a stroke, the majority of MPs joined together to paralyse the only good government available, make Brexit impossible to deliver on schedule or even at all, and produce in much of the population an utter disgust with their proceedings. Most important of all, wittingly or not, they started the countdown to another referendum.

Now, Hague doesn’t want any of this and he says so:

Yes, it is now quite likely that we will have to do it all again. Readers of this column will know that I say that with a heavy heart. For a second plebiscite on EU membership will be the most bitter and divisive event in our modern history, complete with unbridled anger, accusations of betrayal, harrowing doubt and distraction.

But, he is admitting that Brexit’s delay (and probably a second plebiscite) is inevitable at this point in time.

Theresa May will be forced to call time

Again, the problem is a no-deal Brexit. There are too many within the British parliament who want this outcome the least that they are willing to block it. Even in Theresa May’s own party, they are going that route:

Up to 40 members of the government will resign next week if Conservative MPs are banned from voting for a plan to stop a no-deal Brexit, No 10 has been told.

Amber Rudd, the work and pensions secretary, has demanded that all Tory MPs are allowed a free vote on plans that would clear the path for extending Article 50 — the mechanism by which Britain leaves the European Union.

Richard Harrington, the business minister, confirmed yesterday that he would resign if the government pursued a no-deal Brexit.

With the EU unwilling to cede ground, I believe Theresa May will ask the EU for a delay of Brexit. And then the question becomes whether the EU grants this request. Why would they? They have said they aren’t going to change the deal they offered May. And what other purpose does a delay serve than to try and wheedle more concessions from the EU?

This is where the second referendum comes into play. The best way that May will be able to convince the EU to stop the clock on Brexit is to tell them that the UK needs more time for a second vote. Doing that would be political heresy though. So, I’m not convinced May would do it unless forced to by resignations or an act of parliament. And, of course, that leaves the nuclear option of revoking Article 50 as the only way to stop the clock in that instance.

So, my view remains that, although a no-deal Brexit is the default option, it is so unloved, so feared that it will force the UK into delaying or revoking Article 50.

What that means economically or for asset prices is still not clear. That’s because if it is a no-deal Brexit, I expect enough economic and market disruption to cause a financial crisis. But, that’s not my base case outcome. Even so, we are fast approaching the day when the outcome is clear. And we will have to hedge accordingly. Caveat Emptor