The Breakdown - The Potential Consequences of a New China COVID Lockdown

Starting point is 00:00:00 Bringing it back to our first question, the consequences of a new China COVID lockdown, of course, much depends on just how long this lockdown lasts. If it is short, perhaps it only adds minorly to the already intense inflationary pressures around the world. If, on the other hand, it becomes a protracted lockdown that further disrupts the global economy, the consequences could be much more serious. Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexo.i.o, Arculus, and FtX, and produced and distributed by CoinDesk.

Starting point is 00:00:42 What's going on, guys? It is Tuesday, March 15th, and today we are talking about the consequences or potential consequences of a new China COVID lockdown. However, before we get into that, if you were enjoying the breakdown, please go subscribe, rate review, you know, the whole shtick. And of course, if you want to get deeper into the conversation, I would love for you to come join us on the Breakers Discord. You can find a link in the show notes or go to bit.com slash breakdown pod. Also, a disclosure, as always, in addition to them being a sponsor of the show, I also work with FTX. Now, to get this show started, let's go back to February two years ago, 2020.

Starting point is 00:01:23 It's a really weird moment for those of us in the crypto world and to a lesser extent, the financial world in general. Anyone who has sort of business dealings or regular contact with China is watching this new mystery disease just absolutely shut down huge parts of that country. Meanwhile, in the U.S., everything is proceeding like nothing is happening. Stocks aren't paying attention. Markets aren't paying attention. Really, it's business as usual. To get a sense of this weird dichotomy, go listen to my episode with Matthew Graham, who was in China from March 3, 2020. That was two weeks before really anything in the West had changed at all.

Starting point is 00:02:02 Now, of course, we know what happened next and what the preceding couple of years have been like. And so with that context in mind, I want to start this show with this quote from Neil Irwin, the chief economic correspondent at Axios. He writes, We're currently living in the brief moment between when finance and econ Twitter has realized that the new COVID lockdowns in Shenzhen are going to have a hugely bad consequence for U.S. inflation, but that has not yet become widely reported conventional wisdom. Ominous, ominous indeed.

Starting point is 00:02:33 So what's going on? Well, Bloomberg started reporting two days ago that China had locked down Shenzhen City and Jilin province. In Jilin, residents are forbidden from leaving. In Shenzhen, 17.5 million residents are in lockdown for at least a week. Apple supplier Foxcon has halted operations, and Hong Kong is also dealing with increased cases. Shanghai has suspended in-person classes and is shutting down interstate. city bus service. So what prompted this? COVID-19 rearing its ugly head again. A few days ago,

Starting point is 00:03:03 cases doubled in a single day, and it's not just cases going up its deaths. Over the last couple weeks, cases in Hong Kong hit 6,000 per million, and deaths hit 25 per million per day, which is the worst death spike of the pandemic. John Burden Murdoch from the Financial Times gives a little bit of background and explains what might be going on. Quote, I'm not sure. I'm not sure people appreciate quite how bad the COVID situation is in Hong Kong, nor what might be around the corner. After keeping COVID at bay for two years, Omnacron has hit Hong Kong and New Zealand, but the outcomes could not be more different. After accounting for lag between infection and death, one in 20 cases in Hong Kong currently ends in death. To put that into context, Hong Kong's case

Starting point is 00:03:46 fatality rate is currently higher than England's pre-vaccine peak, two years into the pandemic. comparing Hong Kong to its peers, all of whom kept COVID largely at bay for the best part of two years, it's extraordinary the extent to which it is an outlier in terms of the lethality of this wave. So what's driving this? Vaccines. Or more specifically, the elderly vaccination rate. When Omnocron hit, more than two-thirds of people aged 80-plus in Hong Kong were still unvaccinated, compared to a couple of percent in New Zealand and Singapore. This was a year after vaccines became available. Exacerbating this is that most of Hong Kong's elderly vaccinese had China's non-MRNAsinovac shot, which is less effective than Pfizer, etc., at blocking infection.

Starting point is 00:04:31 Xanovac does fare better against severe disease, but overall this is likely to have contributed to the poor outcomes. Earlier, I warned about what might be yet around the corner. Aside from Hong Kong itself, where the surge in cases in recent days is sure to have locked in hundreds more deaths, the looming crisis is in mainland China, where elderly vaccination rates are only slightly better than Hong Kong. Around 15 million over 80s in mainland China are still unvaccinated, an astonishing number. In recent days, China has locked down tens of millions in several cities, as it braces for a much

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Starting point is 00:06:53 Let's talk now about economic effects of these lockdowns. The market dog writes, I don't need to mention Hong Kong is an important logistics center, do I? Eighth biggest port, largest air cargo airport. And what about Shenzhen? Well, go to the market dog again. Shenzhen locking down 17 million inhabitants shows once more that there's not going to be supply chain normalization soon. This could take years or decades. Shenjin is the fourth largest port in the world. There's a high chance this will create disruptions. Shanghai has also displayed a growing number of cases and could be next in line for lockdown.

Starting point is 00:07:25 Shenjin in the entire Greater Bay Area is a very important region of industrial production. The GDP of Shenzhen is equal to a country of the size of Belgium or Sweden. The GBA is equivalent to Canada and Brazil. For example, Luxshare who makes AirPods has its headquarters in Shenzhen, as does Foxcon, a major supplier for iPhones. It's not really rocket science to understand that this will be impactful. The Biden administration is talking about supply chain resilience. Bad news. It won't happen. And the more dollars they will throw into this, the worse it will be. The higher the inflation in the U.S., the more U.S. companies have interest in producing abroad. The more the U.S. is reliant on offshore supply chains. There's no sign of slowing down,

Starting point is 00:08:03 is inflation and higher wage growth in the U.S. will feed this self-reinforcing monster. This means an additional supply shock is coming. Spencer Hacamean adds, the lockdown of Shenzhen should be getting a lot more financial news coverage. So, how are China-related markets handling this? Jim Bianco tweets, how serious is this lockdown in China? Ask their stock market. NASDAQ Golden Dragon China Index extends drop to 13%. Biggest decline ever.

Starting point is 00:08:31 Jim Brusuelas, the chief economist at RSMU. says, a good there's going to be another round of supply chain disruptions morning to all. China's decision to lock down Shenzhen due to Omicron caused the Hangseng Tech Index to fall more than 11% and the larger HSI to decline 4.97%. More kindling for the inflation fire. Indeed, as you can tell, it's not just the short-term market issues that people are focused on. There is a lot of doom and gloom out there from people paying attention. Michael Geyad, the writer of the Leadlag Report newsletter, says, so Shen Zhen locking down is deflationary, right? We are all fucked. If these dynamics hold,

Starting point is 00:09:07 what's coming is going to be far worse than COVID. Evan Sutton writes, Shen Zhen produces 90% of the world's electronics. If the shutdown there lasts more than a few days, we'll see shortages and price spikes on everything from AC units to iPhones to OLED TVs. Maybe this is a good time to talk about the imperative of bringing manufacturing back home. Cheap stuff is nice, but if the supply chain is so brittle that a problem in a single city, can paralyze the world economy and drive price drums around the globe? Maybe we should all pay a little more for a more resilient economy that's better for workers in the planet, too.

Starting point is 00:09:40 So, of course, the straightforward issue here is the continued and demonstrated lack of resilience in the just-in-time supply chain system that we've built over the last two decades. The consequences of this came calling first during COVID and in multiple ways. At the beginning, remember, there was no PPE available, no masks that you could order because they were all produced in China. We didn't have that capacity in the U.S. anymore. But next, it came as we tried to unwind lockdowns and get supply chains back to normal. Remember, the Fed weren't just insane liars when they were talking about transitory inflation.

Starting point is 00:10:12 They were viewing it as transitory because they believed that it was caused by, one, pent-up consumer demand, in other words, people who had been locked down wanting to go up and buy the things that they hadn't bought for the last six months, a form of demand that they assumed would be temporary. And two, they believed that supply chains would resolve themselves, would get back to normal. Factories would come back online and everything would go back to the way that it was. They didn't anticipate, first, major dropouts in the workforce, which would cause wage price pressure, and two, just how hard it was going to be to get supply chains back to normal. The problem now,

Starting point is 00:10:46 of course, is that things haven't resolved. Supply chains remain disrupted and clogged. Workforce participation remains low, creating inflationary pressure on wages. And now we've got this conflict in Ukraine that is politically blocking access to one of the world's biggest exporters of a lot the raw materials that drive the global economy. In other words, this is a much dicier situation for further supply chain disruptions to come into than the first one. There is, of course, more geopolitical backdrop as well, which is the continued question of how China is going to play this new hand they've been dealt by Putin and Russia. I discussed this extensively in the Bretton Woods three episode on Friday. My point in that show was that I didn't believe

Starting point is 00:11:24 a priori that China was just going to jump into bed with Russia. To do so would have serious implications for their relationship with the rest of the world. However, this doesn't mean that they wouldn't ultimately decide that it was to their benefit to take advantage of this moment. And the situation has gotten even more complex since then. Yesterday, the Financial Times reported that the U.S. was telling allies that China had, quote, signaled openness to providing Russia with military support from F.T. Two officials familiar with the content of the cable said Washington had told allies that Russia had asked China for five types of equipment, including service-to-air missiles. The other categories were drones, intelligence-related equipment, armored vehicles, and vehicles used for logistics and support.

Starting point is 00:12:05 Now, there was tons of chatter about this, but if you read these reports, the clear thing is that both China and the U.S. are keeping their positions incredibly close to the vest here. There was reportedly an intense seven-hour meeting between China's top foreign policy official and the U.S. National Security Advisor in Rome yesterday as well. The U.S. is not publicly confirming anything about this nor anything about the FTs report. China, meanwhile, continues to remain officially neutral while getting in its digs here and there at the West's portrayal of the conflict and China's role in it. And what about continued trade and reserve currency questions? We continue to get more dribbles on that front as well. Archim Lucan, who's an international relations scholar at Far Eastern Federal University and Vladivostok, writes,

Starting point is 00:12:47 talk to a Vladivostok-based friend who does trade business with China. He says Chinese now avoid the major Russian banks sanctioned by the West when making dollar transactions with Russian partners. but they have no problem conducting yuan payments via the sanctioned banks. As for dollar transactions, Chinese traders and their Russian business partners switch to non-sanction banks in Russia. Another headline from Walter Bloomberg, Belarusian Prime Minister says Russia and Belarus will ditch payments in U.S. dollars

Starting point is 00:13:11 for energy supplies. This is all barely scratching the surface of the shifting sands of alliances right now. There are questions of India. Will it take advantage of cheap energy and food from Russia that no one else is willing to buy because of the potential political implications, and risk U.S. sanctions wrath. There are questions around Saudi Arabia. Is there the beginning of a new petro-Uwan regime beginning as Saudi looks to do deals with China denominated in yuan? And then what about Latin America? There seems to be a rise in protectionism. Stephen Poonwasi, a contributor at Business Insider,

Starting point is 00:13:47 tweets yesterday, Argentina is the top exporter of soybean meal and oil. They represent 48% of global soy oil exports. They just banned export. This doesn't just pressure soy oil prices, but all cooking oil since other products will be used as replacements. As you can see, this is a punctuated equilibrium moment. Alliances are shifting everywhere, and this is likely to be an extraordinary period of exactly that sort of shifting and change. Bringing it back to our first question, the consequences of a new China COVID lockdown, of course much depends on just how long this lockdown lasts. If it is short, perhaps it only adds minorly to the already intense inflationary pressures around the world.

Starting point is 00:14:31 If, on the other hand, it becomes a protracted lockdown that further disrupts the global economy, the consequences could be much more serious. Whatever the case, the upcoming FOMC meeting got a a whole lot more interesting. Even if you don't agree with all of their decisions, pour one out for the intensity of the pressure for Fed officials right now, right? Anyways, guys, it is interesting times, and I'm glad to have you here with me. For now, I want to say thanks again to my sponsors, nexo.io, Arculus, and FTX for supporting the show. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other.

Starting point is 00:15:05 Peace. Hey, breakdown listeners, come join CoinDesk's Consensus 2020, the festival for the decentralized world this June 9th through the 12th in Austin, Texas. This is the only festival showcasing and celebrating all sides of the festival. of blockchain, crypto ecosystems, Web3, and the Metaverse, and is designed for crypto-newbies, investors, entrepreneurs, developers, and creators. Don't miss speakers like Kathy Wood, SBF, C-Z, Punk 6529, and Joe Lubin to name just a few. Use code breakdown to get 15% off your pass at coindex.com slash consensus 2022.

The Breakdown - The Potential Consequences of a New China COVID Lockdown

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