China and stagflation. What if they pass this on to us now?

At the start of summer, we saw the world coming back to life. The vaccines had filled us with unparalleled optimism; there was no sign that this was over yet. A virus that had arrived from the Far East – though not like the Three Wise Men, although it did arrive at a similar time of year – and a storm with a name straight out of a comic book had failed to wipe us out. But the end of summer arrived, and the annual floods were accompanied by a volcanic eruption. What else could possibly happen? Well, we hadn’t realised quite enough that, once again, China would push our problems into the background. In the wake of COVID, China and its communist regime may well pass on to us a massive inflationary problem, for which the only ones to blame – and we should acknowledge this – are we Westerners, for having allowed ourselves to become dependent on China. A tsunami triggered by the bursting of a property bubble accounting for 18 per cent of its GDP is creating a financial crisis; poor Chinese gas planning is causing an exorbitant rise in electricity prices in Europe; and communist intervention in the market is leading to an export deficit. What might this lead to?

4 October 2021 Reading time: 6.30 mins

These days we are seeing news stories that are hard to make sense of in a world that seemed to us to be clearly on the upswing and emerging from a deep crisis caused by the COVID pandemic.

It’s not just that electricity is expensive in Europe; we’re constantly reading news stories about power cuts in China and, without meaning to, we link the two, but the situation is so different in both places that it seems impossible for them to have similar consequences. But that’s not the end of it: the withdrawal of monetary stimulus by central banks – something that, on the face of it, seems entirely unrelated – forms the perfect triumvirate for the emergence of that red dragon with the cursed name: stagflation.

“In the mid-1960s, a British minister coined one of the most dreaded terms in economics: ‘stagflation’ – inflation without growth.”

China is experiencing constant power cuts in both homes and factories across two-thirds of the country – and, unfortunately, in the two-thirds with the highest population density. This covers almost the whole of southern, central and eastern China. If we were to divide the map of China with parallel diagonal lines, only the western third would be spared.

To understand this situation, it is important to realise that, despite the decarbonisation policies promoted in China by President Xi Jinping, the country’s reliance on coal for electricity generation still exceeds 60 per cent. However, in China, the price of electricity is controlled by the Chinese Communist Party (CCP), meaning it cannot exceed a certain level. This is similar to what some are seeking to impose in Spain.

“A government can set the selling price of a good or service, but unfortunately it cannot set the purchase prices of supplies”

In a regulated market such as the electricity market, it is possible to prohibit selling above a certain price, but unfortunately it is not possible to force producers to keep costs down. The shortage of coal, due to low imports from Australia – caused by strained relations stemming from tensions in the South China Sea – is resulting in high supply costs.

High purchase prices and regulated selling prices result in losses, which the PCC does not wish to socialise – that is to say, it does not want the State to foot the bill – so producers respond in the only way possible: by ceasing production, which is leading to the current electricity shortages.

Allow me, dear reader, to digress for a moment. It would do no harm if those brilliant minds who are calling for a cap on electricity prices in Spain were to turn their attention to the country whose ways they wish to emulate.

“The PCC’s growth model is based on excessive and sustained growth in domestic consumption”

On the other hand, the expansionary monetary policy pursued by the Chinese government and the growth model based on domestic consumption, designed to keep the population content, have led to ever-increasing electricity consumption.

You don’t need to be a Nobel laureate to realise that the situation is explosive: growing demand is being offset by dwindling supply.

Well, the PCC hasn’t come up with any other solution; since it refuses to liberalise electricity prices, it has no choice but to demand that businesses and households reduce their consumption – in a word: power cuts. And these power cuts are, and will continue to be, either voluntary or compulsory. This is hardly befitting the world’s second-largest economy.

“A shortage of energy will inevitably lead to a drop in production”

These power cuts will inevitably lead to a fall in productivity which, however much the CCP may wish to ignore it in its forecasts, will be reflected in its growth figures. And this will result in a reduction in our imports from China. And just before the pandemic, we saw just how dependent we in the West are on China for manufacturing.

Compounding the situation is the gas crisis. Here, the problem is primarily due to poor planning, including on the part of the Chinese. Sixty-one per cent of global liquefied natural gas (LNG) consumption is used as fuel in factories, with the majority of the remainder being used by commercial premises and households.

Gas consumption for transport of any kind is negligible, which is not the case with oil, where almost 60 per cent is used for this purpose. This is why the market prices of these two fossil fuels are so out of step with one another.

The world’s leading exporters of LNG are the USA, Russia and Qatar, although the largest reserves on the planet are found in Siberia, in Russia.

China relies primarily on gas from Qatar and Russia, but their forecasting has been appalling and they failed to store enough gas during the spring and summer, so they are now turning en masse to the ‘spot market’ to buy gas, causing the price rises that we see indirectly reflected in our electricity bills.

“No one should expect much help from the Russians if their winter is colder than usual. Putin knows full well who he must protect.”

Winter is approaching and the Russians, Europe’s main suppliers, need to replenish their stocks, which is why exports are being further restricted. This shortage of supply is causing many Chinese factories to see their production curtailed, as they are unable to pass on the increased costs to their prices.

Well then, a shortage of gas for production and power cuts caused by low electricity output are the perfect combination for suddenly weakening an economy, whilst at the same time driving up the prices of manufactured goods. This is a perfect example of stagflation, a term coined by the British Conservative minister Ian MacLeod back in the mid-1960s. It is perhaps the worst nightmare for any economy: rising prices in a poorly performing economy – that is to say, low growth and possibly unemployment.

As my mum used to say, I’ve already given the Chinese a piece of my mind – I’ve got nothing against them personally, but I must admit I’ve had enough of them after COVID, then the property crisis, and now this.

But how is this going to affect us? Well, badly. The fact that the world’s second-largest economy is facing these problems, coupled with a potential financial crisis stemming from an unchecked expansionist model in the property sector, is bound to be a cause for concern.

Can we catch the bug? Well, it seems we can; now we’ll see to what extent. Nobody doubts the Western industry’s dependence on Chinese supplies any longer. We experienced this before the pandemic, when China’s lockdown brought Chinese factories to a standstill, leading to shortages in our own. We’re experiencing it now due to the shortage in chip production, where, to give just one example, many car manufacturers such as Renault have had to halt their production lines several times, sending their share price plummeting. And we’re set to experience it because of their energy crisis, which, incidentally, is creating our own.

“Unfortunately for our interests, the highly likely Chinese stagflation is going to affect us – or is already beginning to affect us – according to German data”

Turning to Europe, much higher energy costs and a shortage of supplies from China are set to cause – indeed, are already causing – an explosive rise in prices, but in economies such as Spain’s, which are still very weak. Spain, contrary to what we are being told, is not going to grow by more than 6.5 per cent this year, and we will have to see if we even reach 5 per cent.

In the middle of the pandemic, I predicted a full recovery in Spain by the end of ’22. I was then forced to push that date back to early ’23. Nothing substantial has changed since then, except that the vaccination programme is now three months ahead of my estimate. I thought we would have reached this level of vaccination by Christmas, but, to my surprise, the vaccine manufacturers have managed to produce three times as many doses as they did before the pandemic. It’s incredible, and they certainly deserve my recognition.

Meanwhile, Western central banks are beginning to wind down their support, which is set to exacerbate these problems. I do not know whether it will turn out as it did in March 2020, when Powell had to reverse all the measures he had taken over the previous three months – not only cutting interest rates but also resuming monetary expansion.

My advice to anyone who’s taken the champagne out of the fridge is to put it back for now – you might find it goes down the wrong way if you drink it now.