There has been much talk over the past decade about the comparatively low level of aggregate capex spending in the US and Europe. Low investment spending, despite ever lower interest rates, are the main reason why such absurdities as negative rates and endless QE are necessary according to the economic mainstream – because, you know, liquidity trap.
I have been writing about this issue in the past (here) and recently had a discussion in the comment section of the quite interesting moneyness blog (here) on this topic. In essence, I argued that there are many factors affecting investment decisions, the interest rate is just one of many and for some sectors and industries clearly not even the most important one. Economies are too complex to be modelled assuming a simple linear relationship between interest rates and investment spending.
And then I came across this chart,
Who says there has been no capex growth?
With the CNY being more or less fixed to the USD over this time period, it certainly is logical to include China into any analysis involving the effect of Fed policies. As you can also see, investment levels really took off in the aftermath of the financial crisis. Contrary to what one reads, it seems that low interest rates and QE have indeed boosted investment spending. Just not in the US and Europe.
Now, the interesting question: why China, and not the US (or Europe)? Why has there been no corresponding boost in investment spending in the developed economies?
Well, as I already mentioned, there is more than one factor at work. And for various reasons low interest rates seem to have “worked better” in China. From environmental regulations to more flexible labour laws etc. there are ample arguments why China has responded the way it has.
But the most important factor, I believe, is due to the top down decision making process employed by the Chinese mandarins that underlies most investment decisions. Actually, the decision function of Chinese communist leadership likely even resembles the abstruse models the Fed uses to set the “correct” interest rate – similar, that is, in its simplicity of cause and effect. Add to this the supremacy of political objectives over the profit motive, leading to the subsidization of loss making industries ad infinitum and you get the dynamics depicted in the chart above.
Naturally, the decisions made in China, however uneconomic, affect the profit expectations of private businesses in the US and Europe as well. Unless you are a capital goods (think Germany) or commodity exporter (Australia), you will be cautious to expand your business organically knowing you are competing against an irrational market participant with deep, deep pockets. Think steel, think solar panels and many other sectors. Moreover, the announcement of the Chinese to enter into any sector higher up the “value chain” must send shivers down the spine of board members in the respective industries. No wonder buybacks and M&A are more attractive.
The Chinese cannot do this forever, of course as costs are increasing even in the absence of tighter Fed policy. But the capacity of the Chinese leadership to stick with irrational economic decisions is a function of low Fed rates and increasingly so. The lower the opportunity cost of financial folly, the longer it endures and the argument can be made that low Fed rates actually crowd out productive investment in the US in Europe. Which is to say the Fed is responsible. Couple that with the devastating effect negative rates have on banks’ business models and you get the picture (here).
No matter how you look at this, the CNY is at the centre of global economic imbalances. The recent market calm and the likely shake out of the large CNY short position recorded at the beginning of the year (here) have led me to double my CNY short position at reasonable cost.
Disclosure: short CNY, short AUD