THE NEWS

Authored by Daniel Lacalle,

In the past decade, the Chinese economy has expanded its central-planned neo-Keynesian model that simply cannot survive without a trade deal. The Chinese manufacturing sector has followed a running-to-stand-still strategy that simply cannot subsist without the enormous trade surplus with the United States.

The Chinese manufacturing sector overcapacity is not an anecdote. It is the norm. China produces 30% of the world’s manufacturing goods but consumes less than 18%, according to CKGSB. Additionally, China’s industrial capacity utilization rate fell to 74.1% in the first quarter of 2025.

China’s Keynesian central planning model aims to maximise employment and maintain strong economic growth, despite financial constraints and excessive indebtedness. Thus, it needs to sell its excess production to avoid a massive problem of working capital. Even the government has recognised the problem in a roundabout way, noting that “involution”-style competition (wasteful competition) is a major focus for the 2025 economic policy, and steps are being taken to reduce unnecessary investments and control growth in some industries. However, overcapacity in China is not a fatality; it was created by political design, with local and national authorities trying to boost GDP at any cost.

The model is aimed at keeping full employment and economic growth even with economic returns below the cost of capital, and it almost works if the excess capacity can be sold globally, receiving reserve currency and maintaining low costs by passing the working capital cost to global consumers and maintaining low production expenditure with currency controls and exchange rate fixing. However, the combination of rising debt, a constantly weakening currency, and the escalating bankruptcy and working capital issues could potentially bring this model to a collapse, even in the absence of an official recession.

China has learnt that it cannot endure a trade war and cannot substitute the US consumer, the richest and largest market, with European or Latin American consumers. Therefore, it needs a trade deal quickly before the domino of bankruptcies that has plagued the Chinese economy since 2021 erupts into a full-blown financial crisis.

China is officially in deflation for the third consecutive month in April. Business insolvencies are projected to increase by 7% in 2025 and by 10% in 2026, according to Allianz, even as the government implements additional fiscal stimulus.

Small and medium-sized enterprises, particularly exporters, are facing mounting bankruptcies due to declining cash flow and the elimination of US tariff exemptions. Job losses are rising in export-dependent regions, and the urban unemployment rate is expected to average 5.7% in 2025, above the official target, according to CNBC.

The official NBS Manufacturing PMI fell sharply to 49.0 in April 2025, the steepest decline since December 2023, reflecting a drop in output, new orders, and employment, with foreign orders shrinking to their lowest in at least eleven months.

The collapse of the real estate sector, which once accounted for up to 30% of GDP, has weakened banks, reduced household wealth, and led to a negative wealth effect, further depressing consumption and credit demand.

China’s economic strengths are well known, but the weaknesses are too important to ignore. The situation serves as a reminder that central planning never works. Everything that is weak in China comes from previous years of government policies aimed at boosting economic growth by building stuff and hoping it would sell at some point. Furthermore, rising bankruptcies, an imploding property market, and mounting local government debt strain the financial system just as non-performing loans from the Belt and Road Initiative (BRI) soar. Several BRI countries have defaulted on their debts or required IMF bailouts, including Sri Lanka, Zambia, Ghana, and Pakistan, while the BRI generated $385 billion in off-the-books debt.

Keynesian policies always lead to high debt and stagnation. However, when combined with a centralised planning system, a closed financial system, and capital controls, Keynesian policies create a dangerous mix of overcapacity, poverty, and economic slack. China can only begin to address its enormous working capital problem through a quick and successful trade deal with the United States. It will benefit China enormously if the government opens its economy, lifts capital controls, and allows the private sector to breathe. An implosion of the overcapacity problem hidden from the media, offset by even more central planning and stimulus spending, is only going to weaken China in the long run.

Authored by Peter Tchir via Academy Securities,

While the deal hasn’t been finalized, it looks like for the next 90 days (at least, as extensions become the norm), the U.S. is back to 30% on China while they are at 10% on the U.S.  The Fentanyl related tariffs might be higher, but sounds like that can be reduced too, if it hasn’t already (I am not 100% sure on those details, nor where steel and aluminum fit in, or prior levels of tariffs, like the 100% on solar panels that the Biden administration put on).

I would expect announcements that China will buy various products from the U.S. (particularly in the ag space). Haven’t seen those yet but would be shocked if they aren’t part of the deal (similar to what was agreed before Trump 1.0 left office that the Chinese never delivered on).

There should be some language around intellectual property rights (which will be nice, but of dubious enforceability).

There might be some rules about transshipment, the practice of sending goods from China to one or more intermediary countries, to achieve lower tariff rates than direct shipment would include.

With these tariffs, we are back to levels,  in the realm of what was in place ahead of Liberation Day.

• At 30%, much of the tariff can be absorbed by some combination of the supplier, the importer and even FX rates, so the “pass through” to the consumer should be contained.

• The 30% tariff will generate revenue for the government, which has been an important part of their strategy to get the 2026 Budget through (which is extremely important for more growth).

• At 30% it will provide time to move manufacturing, if companies decide to. 30% might be low enough on some things to not force change (though given everything going on, expect most companies to shift away from China faster than they have already been). How much of that is brought back to the U.S. is questionable, now that it looks like the administration is heading towards 10% tariffs (the current “minimum” negotiated with the U.K.) and 30% with China (who we still view as the main competition).

• Expect a series of deals to be announced now that we seem to have the “best” case (U.K.) and “worst” case of China as boundary conditions.

For the first time in months, companies should be able to plan, or at least start formulating plans, with those “guidelines” in mind.

Companies, should also note, that CEO’s meeting in D.C. with the administration, and even those publicly pushing back on media, with valid arguments, seem to be getting their way.

Bottom line is that on tariffs, the President spoke, the market listened and reacted poorly, the administration watched market reactions, and started softening their stance and here we are, back at something that may or may not deliver the goals of the administration but is certainly in the “manageable” range for global markets.

We might never know why 50% was “leaked” on Thursday night, why the President, on truth social, sent out on Friday that 80% seems about right, but the good news is that each social media post will translate to smaller market moves (which is a good thing).

Trump did say to buy stocks during the U.K. deal press conference and so far he is 2 for 2 when he says that!

It does seem that the President is back to viewing stocks as an up to date measure of his policies and that he wants it higher because it means he is winning. We are all very familiar with that from Trump 1.0 and it seems that we can be at least somewhat comfortable that he is back in this stance. The Main Street over Wall Street narrative seems to be over, though I think the two “streets” go hand in hand if we are going to create successful policy.

More Announcements

The President is going to push for drug prices to be “universal”. The administration is clearly upset that the same drug has very different price points across the globe. While this can exist in other products as well, the drug industry is unique. Other products often have local variations making comparisons to domestic markets difficult. Heck, it is hard to get “lowest price” guarantees in the U.S. as each box store seems to get a slightly different version of things, like TV’s, with just enough tweaks, that they aren’t the same product.

But the biggest difference is that the U.S. government effectively bears a chunk of this cost (primarily through Medicaid).

This is not an area we’ve focused on and there are some concerns about viability of forcing this through, but also what impact it could have on drug development, etc.

The President has been “teasing” more big announcements this morning.

Presumably, they will be market friendly as he seems to have reverted back to wanting to see the market higher.

Bond yields are higher, along with almost all industrial commodities, as the risk of recession has yet again been reduced.

In the span of 6 weeks, we went from tariffs that many (including myself) thought would lead to Depression, back to something within the grand scheme of “normalish”. It makes sense to be back to levels in the market last seen around the original tariffs went in place (first fentanyl, then steel and aluminum).

Now we get to figure out what these tariffs (assuming more deals, and the deals in place remain stable), do for the economy, corporate earnings and stock valuations.

For now, expect more positive announcements on trade, but a lot is already priced in. A 3% move in the S&P 500, which is what futures are indicating, is big, but is barely outside of the scope of what has passed for “normal” in the past couple of months – indicating a lot is already priced in.

National Security = National Production

We tried to get Refine “Baby” Refine to catch on late last year and early this year, but settled on National Production for National Security. The admin seems to be trotting out Build “Baby” Build, which is along the lines of what we were eagerly looking forward to.

We need to

• Revisit regulations that were put in place when we were the sole global superpower on the economic front. What may have made sense when China was less of a threat should be revisited now, in light of the obvious competition (it should have been revied years ago, instead of being added to).

• Make government spending commitments where necessary to get these projects into launch mode. Many facilities, from oil refineries, steel and aluminum plants, rare earth and critical mineral processing, require years to get up and running. It will be difficult for private enterprises to start these processes, without having a deep pocketed, committed, buyer. In some cases, this might need to be the government. The Chips act (minus most of the regulatory burden) might be a useful template.

While focusing on this would be implicitly competing with China and the rest of the world, it is far less abrasive than the zero sum game of tariffs and has a clearer path to victory (making more things in the U.S.).

Bottom Line

Given that we have “round tripped” rather quickly on tariffs, there is some degree of head scratching about the point of it all?

Are the “wins” so far big enough that it makes sense? Unclear since the “wins” seem minor so far relative to the status quo before this all started. We also have no clear indication of whether the process helped (lot more manufacturing coming to the U.S.) or hurt (countries shying away from the U.S. and using this respite, to put that into action). I remain more concerned about the latter than excited about the former.

We now have a few months to see how the economy “shakes out” given these tariff levels. We also have to assume, I think, that if any problems start to materialize and get press, that the administration will likely respond. We saw a lot of tough talk, but also the ability to pivot away from problematic (even destructive) polices. Maybe it will be more nuanced before then, but the Trump Put is alive and well.

Let’s see how the 2026 Budget goes (so far hearing all the right noises) and let’s look for more Build Baby Build.

The sooner tariffs get pushed to the back of the line, as a policy tool, the better. That is clearly happening.

We have been on board with the goals of

• Making the middle class larger and wealthier.

  • Through more jobs.

  • Through lower debt and taxes.

We just never felt that tariffs were the best way to achieve those goals, and certainly not as they were implemented on Liberation Day. It turns out (or so it seems) that in the end the administration agrees with us.

Good luck. I think we can all breathe a sigh of relief as things “normalize”.

I suspect our adversaries and competitors learned more about us, than we did about them, during this tariff driven period of policy (it isn’t over yet, the scope seemed to have narrowed, and markets responding to threats or social media posts, is likely greatly diminished).

Technicals, will matter as the overnight moves push the Nasdaq 100 above all of its moving averages and put the S&P 500 right around the 100 and 200 day – important levels of resistance, that if broken, should create more upside.

Bulls seem likely to get more positive headlines in the short term, while both bulls and bears need to put pen to paper (or use AI) to figure out what the likely trajectory is for the economy.

It is far less bad here and certainly not dire, but uncertainty has been high (and likely has some lingering questions) and it is difficult to figure out not just what companies will do in the coming months, it is difficult to anticipate what other countries will be doing, given the events of the past two months.

I continue to think we got to here, because “we” have been making to many assumptions about the rest of the world and how they will respond to U.S. actions. It is right to be optimistic from here, especially since it does seem that the President is back to watching stocks and linking himself to them (rather than admonishing the world that Wall Street would be sacrificed for Main Street).

Having said that, this economy had some cracks coming into the presidency, not the least of which was an overreliance on government spending (running recession fighting style deficits while the stock and job market were doing well!

The bond market is now pricing in the first cut, in September with just over 2 for the year. That might be on the low end.

With all that has gone on, the most difficult thing to do will be to figure out how much of the data and activity in the coming weeks and months is a response to prior policies, and revisions, versus something that approaches a “steady state”.

It has gone from being easy to dismiss good numbers, to likely being easy to dismiss bad numbers, as we adjust. While we are only half way through the 2nd quarter (wow, it seems like we are further into the year for that), many 2nd quarter numbers will have been affected by preparation for tariffs, responses to Liberation Day, and now, to responses to a much more benign tariff environment (one that may yet impact inflation and growth, but in a “reasonable” way, rather than by orders of magnitude).

What a wild couple of months!

This is one of the few times we didn’t publish on Sunday, because the China tariff talks were so important, that it made zero sense to publish ahead of any results from those talks.

Even with some knowledge of what the talks have led to, there is a lot of uncertainty and risk remaining in this market. While the Trump Put is back, if more positive headlines don’t launch us through resistance, we might just meander along as we really do need to figure out what the mix of policy and already shifting economic conditions, and global relationships mean.

Good luck and hopefully this brings us back to a path where we can be optimistic about growth!

Hopefully the April tariff policy was just a nightmare that is settling down and we can move on to things that should provide the positives with less uncertainty!