China’s energy crunch could export inflation around the globe
As China suffers an energy crisis too, the odds of stagflation – slowing growth but rising prices – increase. John Stepek explains why and what that might mean for your portfolio.
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And conveniently enough, upheaval is what we’re talking about today.
Like most of the rest of the world, China has been trying to cut down on fossil fuel usage. China is heavily dependent on coal; it accounts for about 70% of its electricity generation.
But coal is dirty in a very visible manner – pollution and smog always causes discontent. And with China hosting the Winter Olympics early next year, the country has an added incentive to clean up its act.
So it tells you that something has gone very awry when you hear that China is now telling coal miners to dig for all they’re worth, smog be damned.
China’s U-turn on coal sums up what’s gone wrong with the recovery
China’s state-owned miners have been commanded, reports Bloomberg, “to produce coal at full capacity for the rest of the year even if they exceed annual quota limits.”
Meanwhile the price of the muckiest type of coal – lignite from Indonesia – has hit a record level, more than quadrupling in price in the past year.
This is partly because China is still refusing to buy from Australia, but also because all of the energy companies have been ordered to secure whatever supplies they need for winter. “Blackouts will not be tolerated”, apparently.
That’s sent the price of liquefied natural gas (LNG) through the roof too. As one commodities analyst tells Bloomberg: “They will bid whatever it takes to win a bidding war”.
China’s actions show that, as of now, keeping the lights on is more important than keeping the skies clear. Little wonder: factories are already being shut down by blackouts, which meant that September saw the first drop in manufacturing activity since February 2020.
So what’s gone wrong? What’s going on in China is really just an exaggerated (and really quite important) version of what’s happening everywhere else. Surging demand is meeting restricted supply, and it’s all being made worse by governments jumping the gun when it comes to ideals of decarbonisation and energy transition.
Why supply has lagged demand so badly
Every country has its own variations on this theme, depending on where they get their energy from. But the underlying issue is similar across the entire world.
On a broad economic front, post-lockdown demand from consumers has rebounded more rapidly than producers of goods and services were prepared for.
This makes sense. If you’re running a widget factory and suddenly no one can buy your widgets, it makes sense to err on the side of caution, even if it seems likely that demand will rebound when the shutdown ends. In fact, you probably have to err on the side of caution because you’ll need to conserve cash.
So it was always likely that supply would lag demand once the lockdowns started to ease off. Hence the supply chain disruption (which is also made worse by the fact that while domestic economies have opened up to a great extent, the global economy – which relies on smooth cross-border movement – has not opened up to anywhere near the same extent).
This has all been exacerbated by another factor. On the energy front, producers cut back due to lack of demand. But they have the added disincentive of everyone talking about stranded assets and “net zero” and “peak oil demand” and all the rest of it.
It’s not very tempting to invest in extra capacity to meet demand if all opinion and policy points to your products being phased out in the long run. That makes for a tricky balancing act.
So we’re dealing with some big mismatches. In some ways, the world is acting as if we transitioned to net zero in 2020 when in fact, we just switched all the lights off for a short while.
Now that we’re switching them back on, we’ve realised that a “return to normal” also means a return to normal levels of energy consumption, and right now we don’t have a substitute for the dirty fuels that we’re so desperate to stop using.
Inflation is looking less and less transitory
What does all of this mean for investors?
A slowdown in the world’s second-largest economy is not good news. If Chinese factories are switched off, it means they’re not making stuff, which means the energy supply crunch will also morph into a goods supply crunch.
Overall, this means rising costs for companies. And that will almost certainly be passed onto consumers. But consumers aren’t going to take that sitting down either, because there’s a labour supply crunch, too. Which means they’ll be demanding higher wages. Which starts the whole merry-go-round off again.
This is already happening. In Germany, the FT reports, “increasing numbers of German workers are demanding higher pay amid rising inflation, with some going on strike”. For example, the country’s biggest union, IG Metall, is demanding a 4.5% pay rise, plus added pension benefits, for workers at one group of companies in southern Germany.
It’s a similar story in Australia. Capital Economics notes that “union officials’ inflation expectations have surged… A push by union officials to offset rising living costs coupled with severe labour shortages provide fertile ground for wage hikes in upcoming enterprise bargaining agreements.”
To be clear, I’m all for wage rises. A pendulum swing back to labour from capital has been overdue for some time and it’s at the heart of our political discontent. But as we’ve also pointed out on many occasions, this sort of shift would represent a huge change in the investment environment from the one most of us have lived through so far.
What does that mean for your portfolio? It means that if you haven’t given any thought to protecting your wealth from an environment of potentially weaker growth and relentlessly rising prices, then you probably need to.
The “death of the 60/40 portfolio” is one of many topics we’ll be discussing at the Wealth Summit. So book your ticket now.