The China Syndrome

The China Syndrome is a 1979 disaster thriller movie about a television reporter and her cameraman who discover safety cover-ups at a nuclear power plant and stars Jane Fonda, Jack Lemmon, and Michael Douglas. According to Wikipedia:

While visiting the (fictional) Ventana nuclear power plant outside Los Angeles television news reporter Kimberly Wells (Jane Fonda), her cameraman Richard Adams (Michael Douglas) and their soundman Hector Salas witness the plant going through an emergency shutdown. Shift Supervisor Jack Godell (Jack Lemmon) notices an unusual vibration while grabbing his cup of coffee, which he had set down. He then finds that a gauge is misreading and that the coolant is dangerously low (he thought it was overflowing). The crew manages to bring the reactor under control and can be seen celebrating and expressing relief.

The definition of a China syndrome is, “A hypothetical sequence of events following the meltdown of a nuclear reactor in which the core melts through its containment structure and deep into the earth; hypothetically to China.”

We think the movie is an appropriate analogy given last Friday’s Chinese induced “meltdown.” By now everybody knows Friday’s Flop” (-572 Dow points) was attributed to the president’s tweets about the potential for an additional $100 billion in tariffs to the already proposed $50 billion. That would bring the total amount up to $150 billion, to which China said, “We will fight back at any cost against U.S. trade tariffs.” In response to the first $50 billion in tariffs the Chinese made a proportional $50 billion in tariffs on U.S. “goods.” The fear on Friday was that China would make an equal proportional response to the $100 billion of potentially additional tariffs on U.S. goods, but here’s the problem. Last year we exported only ~$130 billion worth of goods to China, so their response cannot be proportional (Chart 1)! Granted, China could do other things.

As we stated weeks ago, they could cancel their orders for Boeing aircraft and switch to Airbus and still be in compliance with the World Trade Organization’s (WTO) rules. Or, they could begin to liquidate their $1+ trillion worth of U.S. fixed income, which they think would crater our bond market. However, the Federal Reserve could counter that move with emergency “open market” operations and soak up the selling. Indeed, if the Fed can buy $3+ trillion worth of Treasuries and mortgage bonds with QEs, it can certainly absorb any Chinese selling. Moreover, if China did manage to trigger a financial crisis, the blowback across the globe would be significant and deeply affect China itself. It would also violate China’s promise to “Protect the multilateral framework.” So, we think the markets overreacted on Friday, a view that will either be proven correct this week, or disproved.