China’s Stimulus and Global Industrial Revival

Which Industries Will Gain from Government-Directed Stimulus and How Does A Period of US Stimulus Spending Differ?

Introduction

Human beings are perpetually cursed. Not in the way a voodoo witch doctor might curse the protagonist of a child’s cartoon but one could argue the effects are equally damning. The collective memory, especially as it pertains to financial history is laughably short, and reminds us of a test done on toddlers to assess object permanence skills. When the toy is directly presented to the child it is all they can think about, eager to play and enamored by the colors, shapes and sounds associated with this alien object. The second the doctor hides the toy the child becomes confused, like a switch was flipped, forgetting that the toy they once had such affinity for ever existed. The same experience can be found in studying empirical evidence of our collective memories throughout financial history.

Participants in financial markets often look to the past as a guide of what is to be expected in the future. To their credit, many times that is a reasonable approach. In most cases one can be reasonably certain that the fundamental truths of today will exist tomorrow and it must be that way. The world needs a degree of perceived certainty to run in a reasonably unchaotic manner. The problem with extrapolation is that when it comes to points of inflection – by this we mean tomorrow’s facts being contrary to the rules with which we engage today, extrapolation falls flat, and shocks occur.

It is our core belief that one of the ways extrapolation is blinding markets is regarding China, where the facts from 2019-2025 are considered a new normal to be extrapolated from, ignoring that the country has been in a significant recession stemming from COVID-19 polices, one child policy rearing its ugly head, a catastrophic bubble burst in its real estate and industrial sectors and a change around the world in globalization and cost competitiveness broadly.

Though China still sees GDP growth in their lean years, the rate of growth is dramatically off its base rate. Recently, to remedy this, China has begun a campaign of government backed stimulus to spur the economy back into a state of strength. The question that is at the core of this piece is how does stimulus differ between what we see in the United States versus China? What industries stand to benefit from mass stimulus in China, and which have been continually beaten down around the world and present opportunities in the next decade?

United States

Reagan proved that deficits don’t matter – Dick Cheney 2003

The American economic system works better than anywhere else in the world. Capitalism and the process of creative destruction has elevated the United States to levels never thought possible just a few decades ago. It used to be that when the US economic system went into a state of lull, the economy itself slowed, Gross Domestic Product (GDP) contracted, and the stock market performed relatively poorly. That process would take anywhere from 6-18 months in most cases and in severe cases like 1929-1933 and 2000 – 2003 stocks languished for an extended period. It was an accepted fact that by participating in the market, recessions would happen and that during those times similar to a flu bug the country simply took its medicine, limped through the pain for a relatively short period and began again to a state of prosperity and growth.

Somewhere along the way that relatively benign flu bug has turned into full on cardiac arrest and rather than simply taking a spoon full of sugar and resting the country is injecting a shot of adrenaline directly into its aorta. No longer do we allow for periods of protracted decline, due in part to the tremendous amount of debt the country owes leading to even a small recession being amplified due to the deficit the country continually operates under the weight of. It was no surprise that when the COVID -19 pandemic hit or the Great Financial Crisis hit that bailouts and stimulus would be used in full force. In times of crisis the government slashes the rate of interest, bails out over extended industries at the expense of the taxpayers and fundamentally sacrifices long term prosperity to avoid any shock to the system in the near term.

There may be no better example of just how far we have strayed from our free market capitalist system than the COVID-19 pandemic and the massive amount of stimulus pumped into the US economy and given directly to the citizenry with the hope that those funds would end up going back into the economy. The question on our mind is with the path the US economy is on, and the safe assumption that that debt pay down and fiscal responsibility will not be practiced, where is our stimulus going, what pieces of the economy are being propped up and who stands to benefit?

Empirical evidence shows that stimulus that is additive has a higher multiplier effect than reimbursement stimulus or cost cutting stimuli. For example, tax cuts are going to have a much smaller impact on the overall economy than setting aside a lump some of funds to stimulate a given industry, adding extra investment and incentivizing others to do the same. The United States historically has done a bit of both, but the problem as of late is though we are setting aside funds for US infrastructure investment almost all of it remains unspent and the money that does get spent doesn’t go to growing the real economy that is directly tied to a growth in GDP.

The Inflation Reduction Act, or IRA which was a $433B of direct investment and $739B of “raised revenues” that was designed to reduce inflation and reduce the deficit by $300B. The issue with this is not only that is hasn’t been spent, but that the $369B of direct investment in “energy security and climate change” was actually going to increase inflation, not reduce it. In addition, this is a plan that was to extend over a 10-year period allowing for $36B a year of investment in energy security and climate change. Even including the IRA additions to energy spending we would not be investing enough to even keep production flat given the natural decline of energy in all forms.

In addition, the spending from the IRA was not being used to grow or sustain domestic oil, gas, or coal production, but instead this was a massive spending bill for energy infrastructure, most notably renewables like wind and solar that are uneconomic even with mass stimulus. Later in the piece we will discuss the Obama Era GFC stimulus that had hundreds of billions set aside for physical infrastructure and it never was allocated due to red tape and a fundamental disinterest in the physical economy.

Another spending plan that was proposed was the CHIPS and Science Act which was a much more “exciting” proposal for the American people and lines up well with where the “puck” has gone over the last 15 years – tech. The key “wins” quoted by the Biden Administration was $50B of American semiconductor spending, $40B from Micron the Dynamic Random Access Memory (DRAM) and Not And or NAND memory chip maker. Additionally, Qualcomm announced a partnership that included $4.2B of spend to manufacture chips in GlobalFoundries’ upstate New York facility.

There were other pieces included that were based in permitting for high tech manufacturing, which was clearly the goal of this spending plan to begin with. One must ask, what is the net effect on the economy broadly for mass investment in semiconductor chip manufacturing? I think there is a case to be made investment in the space is warranted and important for national security purposes, but is it not ironic that while allowing for expediated permitting for semiconductor manufacturing that in his last hoorah in office Biden slapped a ban on new exploration for oil and gas in the US Gulf of Mexico?

The bottom line is we are failing to spend money in the proper places to truly spur economic growth in this country. The money we are spending is not growing GDP in America in a material way that is the entire goal of stimulus to begin with. We are not intelligently allocating money to increase energy security in the slightest and we are actively handicapping ourselves by ignoring our natural gas and oil industries, our metallurgical coal, iron ore, copper, chemicals and steel industries. The dollars the US spends on stimulus are not having their intended effect and neither did the nearly 20 years of artificially low interest rates that did not spur economic growth as was intended but instead inflated financial assets and led to a decade of anemic GDP growth and misallocation of capital on the part of the investment community.

We end our discussion on US stimulus by simply stating American has the most important chess piece to bring about the onshoring of new investment in the US and job creation and it isn’t Bidens IRA or Trumps tariffs - it is low cost energy from the glut of natural gas that North America has enjoyed and will enjoy for at least the next decade, disconnecting North American energy intensive industries from the rest of the world. It is our belief that the largest multiplier of stimulus dollars in America should be spent on building out base line energy infrastructure and leaning into the energy advantage the US and Alberta enjoy against the rest of the world. That, we believe, will be the single best driver of real GDP growth North America could hope for. Chemical production, base metals, and energy intensive businesses broadly have an economic advantage versus the rest of the world, and we are ignoring it at the expense of semiconductors and bad politics.

China