Inflation and interest rates have dominated the world’s attention this year, but it’s China that holds the key to the future of the global geopolitical and macroeconomic outlook – and recent developments look far from promising. 

China is currently flexing its muscles over Taiwan while, at the same time, grappling with a troubled local economy – both of which have significant ramifications for the world as we know it.

Geopolitically, global leaders and investors are on edge, waiting to see what the second-largest economy’s next move will be after the significant escalation in tensions in the wake of US Speaker of the House Nancy Pelosi’s trip to the hotly contested island. 

The Economic Intelligence Unit (EIU) has spelt out three possible scenarios. These include their base case, in which China strengthens its military reach and intensifies pressure on Taiwan. Its moderate-risk scenario, which is that China prepares to annex Taiwan within two years, and its low-risk scenario, returning to the cross-Strait status quo.

Morgan Stanley head of Public Policy Research and Municipal Strategy Michael Zezas doesn’t believe that Pelosi’s Asia trip should be viewed as the catalyst for tensions, “but rather evidence of tensions that persist between the two global powers”. 

He adds that investors would be better served by focusing on the underlying dynamic – the rivalry between China and US that is likely to persist – instead of any particular event. 

This week the Communist Party announced the cessation of its live-fire military exercises, but plans regular patrols. It didn’t count out Taiwan’s reintegration into China, which many view as dependent on when its military strength is equivalent to that of the US.

The EIU’s base case sees China establishing “a new security precedent in the Taiwan Strait by normalising military activities that approach or even enter Taiwan’s claimed territory”. But it doesn’t expect these to result in China invading Taiwan. 

However, it does warn that there is the risk of a miscalculation on both sides, which could “trigger a devastating cross-Strait security conflict”. 

A worst-case scenario of all-out war over Taiwan, though not high on the list of probabilities, would have far more dire consequences for the global order than Russia’s invasion of Ukraine, because it would see two superpowers coming up against each other militarily. 

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In an article titled “US-China tit-for-tat escalations are very dangerous”, founder and co-chief investment officer of Bridgewater Ray Dalio bases his concern on the fact that his US-China Conflict Index is at its highest level since 2000 and similar to that which existed before World War 1 and World War 2. 

His gauge takes into account military spending, personnel and deployment; sentiment of each country’s people about the other country; and media attention given to the conflict. According to his analysis, China’s share of military spending has been on a steady upward march and currently comprises about 20% of global military spending, while the US’s has declined since the early 2000s and currently sits at 40%, narrowing the gap between the two from about 50% to 20% of global spending over the period.

He says the Russia-Ukraine war would be minor by comparison because, in addition to the human cost of a war, the economic ramifications would be far more extensive than the fallout experienced from the Ukraine conflict to date, with China’s share of world trade more than seven times larger than Russia’s. 

“Imagine what the supply chain and economic impacts on the world would be,” he says. “Supply chains would collapse, economic activity would dive, and inflation would soar.” 

These are eventualities that the global economy could ill-afford in an environment where supply chain issues are finally easing, the global economy is at threat of falling into recession and inflation is at multidecade highs. 

The saving grace, however, could be that China has its work cut out for it at home, where it is up against a plethora of economic challenges, unless, as Old Mutual Multi Managers investment strategist Izak Odendaal says, China does choose to escalate the conflict to distract from its domestic problems, “a tried-and-tested approach” through history. 

There was some positive news on the Chinese front this week, when trade figures saw exports increase by a higher-than-expected 18%. However, less encouraging was that imports in July rose by 2.3%, compared with expectations of 4%, which signals that domestic demand is weak as a result of the government’s zero-Covid strategy. 

Odendaal says, in the short term, the state of China’s economy will depend to a large extent on whether it continues to rigidly impose the zero-Covid policy and the extent to which the government stimulates the economy to make up for it. 

Covid cases continue to rise steeply, with the government lockdowns extended further afield to holiday destinations Hainan and Tibet, as case numbers reach a three-month high. On the stimulus front, Odendaal believes these will be limited, given the already high debt levels and the fact that cutting rates or adding more debt is unlikely to be very effective.

His main worry is the slow-motion implosion of the property market, given the central role it plays in China’s economy. 

“Combined with its poor demographics, I therefore expect overall growth rates to continue trending lower over time. Moreover, as the state reasserts its central role in the economy, you have to assume that that will impede productivity growth.”

For South Africa, in particular, the ramifications of a major Chinese economic slowdown/political crisis would be significant. Odendaal spells out three ways in which the country is dependent on China:

• It is a major export destination, primarily of commodities, with export values totalling R200bn last year, according to SARS.
• Some of our biggest JSE-listed companies are directly exposed to China, notably Naspers.
• When China sneezes, emerging markets catch pneumonia, as we saw in 2015, and sentiment would suffer. 

The stakes are high and the one thing we’ve come to understand over the past few years is that “unprecedented” events are not necessarily spaced out over decades. 

Seeing China’s military launch live missiles over Taiwan for the first time is thus an ominous, and potentially underestimated, development. BM/DM