Chamberlain knew that because of years of under-spending on defence, for which he himself (having been Chancellor of the Exchequer before rising to PM) was partly responsible, we couldn't have fought Hitler effectively in '38. He did the best that he could there, to stave off WW2 for a while so that Britain's rearmament progamme would be further ahead when war finally did become effectively unavoidable.
e.g.
Total number of Spitfires and Hurricanes, combined, possessed by the RAF at the time of Munich? c.50
Total number of Spitfires and Hurricanes, combined, possessed by the RAF when Chamberlain gave Hitler an ultimatum over Poland? c.500.
If Britain wasn’t prepared for a European war, it does not mean that Germany was. The decision to use force against Austria and Czechoslovakia, even if it meant war with Great Britain and France caused the German foreign minister, Baron von Neurath to suffer several heart attacks, as stated by Williamson Murray “the strategic situation in 1938 was far more favourable to the Allies than it would prove the following year“.
The Wehrmacht suffered from deficiencies in training and leadership after the rapid expansion of the army since 1933. It consisted of 48 divisions with only 3 armoured (possessing only light tanks, many of them obsolete), 4 mechanised and 4 light divisions, the rest (5 of which being Austrian divisions, not yet fully integrated) being horse drawn WW1 stlye divisions with considerable shortages in artillery and other weapons. With the 37 divisions allocated to Fall Grun, and the 3 kept in East Prussia, that leaves only 8 infantry divisions to defend the Reichs borders. The only reserve that could be counted on were 14 Landwehr divisions, consisting mainly of overage and out of shape First Wolrd War Veterans, who were also under-equipped. The Wehrmacht was not prepared.
The Kreigsmarine lacked heavy cruisers or battle cruisers and only had 7 destroyers and 7 ocean going submarines, a campaign against commerce was out of the question. The Kreigsmarine was not prepared.
The Luftwaffe was exchanging its first generation fighters for more modern models, but by the fall of 1938. However, there were only 500 Bf 109's in front line units, with under-experienced pilots suffering from high accident rates and the introduction of the new aricraft creating complex supply and maintenenance problems such as a lack of reserve engines and pilots. The Luftwaffe was not prepared
Were we unprepared for war in the fall of 1938? Yes. Was Germany even less prepared? Certainly.
Was handing over a massive amount of industry and modern equipment to Hitler whilst neutralising a significant ally to avoid war with this much weaker Germany? You have to be kidding...