Emerging Markets

Most diagnoses of China’s liquidity trap miss the point that policies arising from these theories were developed for market-based economies with governments accountable to their electorates, not autocracies pursuing autarky. As the CCP widens and deepens mass-mobilization campaigns, the echo of the Cultural Revolution will grow louder and lead to further retrenchment by households and firms. China has space at the center for significant fiscal stimulus, which, if deployed, could break its liquidity trap and boost commodity demand.

Deflation prevails in China’s economy. Marginal interest rate cuts will be insufficient to boost growth as the economy is experiencing debt deflation and might be entering a liquidity trap. There will likely be more economic disappointments in the coming months. Chinese stocks will continue to sell off. Government bond yields will fall to new lows, and the RMB will depreciate further against the US dollar.

Indian stocks have gone up this year even as the broader EM markets have been falling. How long can Indian markets continue to rise?

Commentators often use notions like debt deflation, balance sheet recession, and liquidity trap interchangeably. Yet, these are different concepts. This report develops a framework and provides a diagnosis of China’s economic malaise. A follow-up report will deal with what kind of treatment is needed for a recovery. As a trade, we recommend shorting the EM equity index.