One of the world’s premier economic engines is running at its lowest speed in decades. And with a shrinking (working) population, among other things, the longer-term prospects for China are not bright either.
Currently, China is struggling with the impact of the rather abrupt shedding of its zero-COVID policy: hundreds of millions of infections, many deaths, overburdened hospitals, companies coming to a standstill and faltering supply lines.
Nevertheless, the chances seem greatest that — despite all the current misery — it will ultimately be something like ripping a Band-Aid off: There will be many victims among the elderly in particular, production will be hit hard and demand will not emerge unscathed either. However, in a few months from now, the worst will be over and by far the vast majority of the Chinese population will have built up some degree of immunity, at least temporarily.
Xi Jinping’s position will not be jeopardized: Many Chinese are more than happy that the strict COVID measures were abandoned, protests have remained relatively small and October’s Party Congress showed how firmly Xi and his clique are in the saddle. All this means that the Chinese economy will probably be able to start a solid upward trend from the second quarter onwards.
In the alternative scenario, COVID will still cause more havoc in China — and for much longer — than is already the case. This cannot be ruled out, as the official vaccination rate of more than 90 percent masks the fact that Chinese vaccines are far less effective than Western mRNA vaccines and that 30 percent of the 260 million over the age of 60 and 50 percent of those over 80 did not receive a booster. The gloomiest forecasts, for example, assume 1.7 million deaths by the end of April. Should such a black scenario become reality, Beijing may be forced to resort to strict measures again, and/or Xi will take an even harder geopolitical stance to divert attention away from domestic problems and to legitimize an even tougher line against unrest.
In the preferred scenario, the world will be affected by two opposing inflationary forces from China. If China recovers relatively quickly, the giant’s demand for commodities will pick up quickly. It must not be forgotten that China is responsible for almost a fifth of global oil consumption and it is the largest importer of liquid natural gas (in 2021, it was responsible for over 60 percent of the growth in LNG demand). Also more than half of the world’s copper, nickel and zinc demand comes from China and more than 60 percent of iron ore demand.
A rapid recovery of China will therefore put commodity prices under great upward pressure, thereby keeping inflation in the West at high levels. At the same time, production and supply chains will run more smoothly once the world’s factory has resumed smooth operations. This, in turn, will have a depressing effect on the prices of many goods.
In the alternative, more negative scenario, the Chinese economy will be stricken by the (aftermath of the) COVID pandemic for an even longer period of time. In this case, sharply reduced demand for commodities will exert significant downward pressure on commodity prices, with this effect outweighing the potential upward inflationary pressures due to faltering supply chains. As a result, the European Central Bank and the Fed will not have to tighten monetary policies as much as planned, thereby somewhat supporting weakening growth in the West. As mentioned before, however, in the alternative scenario, there is a higher likelihood of Beijing challenging the West (including Taiwan) more to create an us versus them frame in order to garner more support from the Chinese people.
At any rate, there is a growing chance that Xi will resort to flexing muscles on the international stage by way of distraction, as China is struggling with a number of major internal problems in addition to COVID: towering debts, a declining workforce and diminishing economic dynamism due to the ever greater influence of the Communist Party in business and the increasingly pervasive surveillance state. In this case, growing geopolitical uncertainty that will arise if China adopts a(n) (even) more assertive stance in the world could exert additional upward pressure on the prices of traditional safe havens, such as gold, and make investors warier about investing in countries in the immediate vicinity of China, including Japan.
Whether or not the current Chinese COVID tsunami ends relatively well, China will steadily continue with its attempts this year to strengthen its own role in the global economy and global financial markets and to reduce America’s role. For example, Credit Suisse is already speaking of the petroyuan because Beijing manages to have more and more oil and gas paid for in its own currency. It already has deals with Iran, Venezuela and Russia, and Saudi Arabia and the Gulf states will join as well. Russia, Iran and Venezuela combined already account for 40 percent of the world’s proven oil reserves. The Gulf Cooperation Council (GCC) countries also collectively represent about four-tenths. The remaining reserves are almost all to be found in countries located in China’s (and/or Russia’s) sphere of influence.
This means that Beijing will be able to use the fossil energy markets — on which the world will most likely continue to depend for years to come in spite of the intensification of sustainability efforts — to gain more influence in international financial markets, consequently being able to significantly corner the West in the long term.
Andy Langenkamp is senior political analyst at ECR Research which offers independent research on asset allocation, global financial markets, politics and FX & interest rates.