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Central banks around the world are being forced to drastically tighten financial conditions to combat inflation, pushing their economies to the edge of the precipice. But this is not the case for them all. One central bank – in addition to Japan, which looks set to change course soon – is resisting this trend and doing the exact opposite. The People’s Bank of China is easing monetary conditions to support the economy as, far from sky-rocketing, Chinese inflation is levelling out at 2.1%, with this figure falling to 0.9% for inflation excluding energy and foodstuffs. And production prices, which were threatening economic stability in October with a rise of more than 13%, have clearly settled down to an annual increase of 6.4%. Western central bankers can only dream of being in such a situation.
It is lucky that China’s central bank is in a position to support its economy, because this support is sorely needed. The country has suffered more in recent months than at the start of the COVID-19 crisis in spring 2020, even though the pandemic started there. Residential real estate saw a worrying slowdown in 2021, reflected in the near-bankruptcy of one of the major real estate developers, Evergrande. But thanks to government support, widespread meltdown has been avoided. As the peak of this crisis looked to be receding, a new one appeared in spring 2022 with a surge in COVID-19 cases in Shanghai and Beijing. The inflexible zero-COVID policy imposed by Xi Jinping resulted in a brutal lockdown for tens of millions of people. Economic business surveys plummeted: the composite PMI fell from 51.2 in February to 42.7 in April, signalling quasi-recession for the second quarter of 2022.
But government intervention to stimulate lending, ease financial conditions via the central bank and loosen the regulatory stranglehold on the digital sector did the trick and PMI jumped to 54.1 in June. Of course, Chinese data must be taken with a pinch of salt but there is certainly an element of truth there. Chinese shares (as represented by the MSCI China in USD) have reacted to this improvement, rising slightly over the second quarter, whilst global equities have declined by over 15%.
So China is starting to turn the corner. Meanwhile, the fear of recession is spreading in the rest of the world and we are seeing a full swing of the pendulum. Except that, should recession hit the West, it is likely to suffer more than China, as central banks are unable to support the economy during periods of inflation. And on top of this, there is the war in Ukraine. China is not affected by either of these factors, provided it does not decide to directly attack Taiwan.
To a certain extent, the war in Ukraine actually works in China’s favour. On the one hand, the West is urging China not to give Russia its full backing – and in return, the G7 is certainly ready to make some economic and political concessions. On the other hand, both China and India are also starting to benefit as Russian energy exports that can no longer find an outlet in Europe are diverted to the East. This unexpected manna of cheap energy coupled with a deliberate nuclear policy ensures that there are significant means on hand to support the recovery. And the EPRs constructed in China are operational.
So, even if the US is terrified by China’s economic and geopolitical momentum, China is becoming increasingly essential to the western economy, as a fully functioning production and consumption hub that will hold down the prices of imported goods for the West, and act as a source of consumers ready to spend at a time when western consumption has been choked off by inflation. As in every crisis since 2008, despite itself, China is coming to the aid of the West, which would like to do without its help but is increasingly unable to do so. Just like Russia, which is increasingly dependent on the destiny of its huge eastern rival.
Trade with China is thus becoming the path to political suffering and pain for the West, just as it is increasingly looking like the only way out for the economy.
Written on 4 July 2022 – Olivier de Berranger, CIO, LFDE