China’s slump could see the UK rise again

An investor observes the stock market at a stock exchange hall in Nanjing, China, last year (Getty)

Sushil Wadhwani, the hedge-fund manager and one of the earliest external members of Bank of England’s monetary policy committee, had an interesting question for the audience at a conference hosted by Unigestion, the Swiss-based investment group, earlier this month.

If we were hit by another economic collapse, as he thought we soon would be, should the Bank try to revive the economy by printing money and giving it directly to consumers to spend — what is known as helicopter money?

His thesis was that with interest rates already at or near zero, there was no scope for central banks to cut them further and so they were robbed of a key weapon in their armoury.

Helicopter money was therefore one of the few ways in which they could deliver a stimulus to counteract the downturn.

He failed to convince, perhaps because the solution sounded a bit too Jeremy Corbyn for the fund managers’ taste, though it was someone from the other end of the political spectrum, Milton Friedman, who first floated the idea.

Nevertheless, Wadhwani raises an important point: world markets are in a funk because they can’t see where global growth can come from, now that China has slowed down sharply.

Every year, since the onset of the financial crisis, China has been responsible for most of the growth the world has seen.

If that country can no longer act as the locomotive, what else is there to pull the world along? If China drags down other emerging markets and creates a worldwide collapse of demand, what will get the global economy out of the secular stagnation trap, where a lack of demand leads to no investment, no productivity growth, no rise in incomes and so to no increase in demand?

There are a lot of gloomy people about who share his views. But not everyone agrees.

There is also a much more optimistic analysis from Lombard Street Research, which is well worth noting because this independent economics consultancy has an enviable record of getting things right, normally by having the courage to defy conventional wisdom.

For example, it was years ahead of everyone else in warning that the China slowdown would be much worse than expected; before that, it was one of the few to spot the dangers of the world savings glut which fuelled the bad lending that precipitated the crisis.

Now, for the first time in quite a while, it has turned optimistic — albeit it is well aware things could go badly wrong. It describes it as a fork in the road — one branch does indeed lead to a severe global recession as the world is dragged under by China’s problems.

But the other leads to what it calls a deflationary boom. It is this boom that it considers to be the more likely.

Its key insight is that, far from being worried about China’s slowdown, we should be grateful for it because it gives the world economy a much-needed opportunity to rebalance.

China’s growth in the past 15 years has been so fast and on such a vast scale it has left little room for anyone else. That growth, with its demands on resources at ever higher prices, meant the rest of the world was crowded out.

Now, however, the picture is completely different.

The Chinese slowdown has brought a massive drop in world commodity prices. Oil is the most talked about but the declines have been every bit as dramatic across the commodities sector in copper, iron ore, other metals and rare earths and even in some foods.

This is terrible news for the miners, whose shares have tanked and who are trying to sell their worst-performing assets. It is similarly grim for oil producers, who have cancelled drilling and exploration contracts.

But it is great news for the rest of us who buy these things off them because everything is so much cheaper.

It is like the rest of the world has been given a tax cut, and it represents a massive shift of economic power and wealth from producers to consumers.

The only reason the beneficial effects of this are not already more apparent is that you feel pain before you feel gain. It is part of the human survival instinct that you react immediately to pain and take defensive action.

People respond in a more measured way to something that makes them feel better because they wait to make sure it is for real and lasting.

That is why, across the world, oil companies and miners are slashing their spending as they struggle to learn to live in the new world. This of course adds to the immediate perception of gloom.

But before too long all that extra money will burn a hole in consumers’ pockets.

Their additional spending will create a surge in demand which in turn will encourage an increase in investment. Higher investment leads in turn to higher productivity and makes it possible to pay higher wages. This sets off a further increase in spending.

This is the virtuous circle of economic growth which contrasts sharply with the fear of secular stagnation which dominates so many economic conversations. So that’s what a deflationary boom is.

Lower prices give people money to spend. Their spending creates prosperity.

The other point of the LSR analysis is that Europe will be a major beneficiary of this because, with a few exceptions, we are raw materials consumers rather than producers.

The US will also do well but Asia and emerging markets will struggle. China’s efforts to remove its dependence on cheap exports and rely more on domestic consumption is a massive undertaking that will take years to complete.

Things could go wrong, of course, but the base case is plausible. It happened like this in the Eighties when the oil price plummeted.

First, we had the recession as producers cut, then the boom as consumers began to spend.

There is good reason to believe it will not be different this time