In October 2020, China won plaudits as the first major economy to emerge from the Covid-19 pandemic, reporting quarterly growth that was seen as an endorsement of Beijing’s zero-tolerance policy, or locking down cities and millions of people at the first sign of an outbreak. 

How that narrative has shifted. 

China’s so-called zero-Covid policy is now seen by some analysts as a disrupter of the world economy, rather than leading a recovery, and is generating uncertainty for all financial markets, including cryptocurrencies.

“China’s economy is clearly contracting sharply under the weight of zero COVID policies,” according to a May 31 report by U.S.-based think tank Rhodium Group, which specializes in research into the country’s economy, the world’s second biggest. 

“Consensus expectations have not fully factored in the degree to which China’s economy is weakening this year, or the probability that slower growth will extend into future years,” says the report, titled Rethinking China’s Economic Future.

The 25 million residents of Shanghai, one of the world’s leading cities, emerged last week from a two-month Covid-19 lockdown that shut factories, offices and transport networks in China’s financial center and had people forming groups on social media to barter for foodstuffs.

Truck not

An example of how China’s Covid-19 policies can paralyze a city’s basic supply networks was explained by an official at milk delivery company Guangming Dairy in Shanghai. 

“We produced the milk, but we couldn’t deliver it to customers and we had to absorb the losses,” the official at the subsidiary of China’s second-largest food group Bright Food Group told Forkast on May 31.

Failed milk delivery is a microcosm of the transport disruptions that take place across China when a city or region is locked down under zero-Covid.

National truck flows fell 27% in April from the same period last year, according to G7 Connect, which tracks truck shipments. Trucks carry about three-quarters of China’s total freight, according to official data. 

“The fact that they’re still going to maintain this zero-Covid policy is a big overhang still on the markets,” said Andrew Sullivan, who spent 17 years trading equities in Hong Kong, including at BNP Paribas.

Pebble in pond

The Shanghai shutdown reverberated far beyond China as companies such as Tesla Inc., Toyota Motor Corp., and Apple Inc. reported factory closures and broken supply chains. 

The zero-Covid policy is generating new concerns about China’s economic future, and its position within the global economy, according to the Rhodium report. 

“Financial markets have reacted accordingly, selling Chinese assets in large volumes, while corporates reassess the importance of China within their global strategies,” the report states.

Sullivan notes that companies were already looking at reorganizing supply chains because of U.S. tariffs on China and that will accelerate because Beijing is expected to continue the zero-Covid policy.

Apple is reportedly planning to move some of its assembly production to Vietnam from China, which may lead to opportunities for companies in Vietnam to make component parts, he said. This in turn would attract more Apple suppliers to the country, said Sullivan, who now writes commentary on Asian markets.

The snarl-up in supply chains out of China has added to inflationary pressures elsewhere around the world, with inflation hitting a 40-year high in the U.S. to trend around 8.5% monthly this year. 

U.S. Federal Reserve Governor Christopher Waller said this is a combination of strong consumer demand and supply constraints, when he spoke May 30 at the Institute for Monetary and Financial Stability in Frankfurt, Germany. 

“I support tightening policy by another 50 basis points for several meetings. In particular, I am not taking 50 basis-point hikes off the table until I see inflation coming down closer to our 2 percent target,” Waller said.

Not a chance

The threat of higher interest rates to tame inflation is driving equity markets lower, with the Nasdaq in May posting a five-week losing streak, the longest since 2012. 

Bitcoin investors have also been spooked by inflation — despite the asset’s reputation as an inflation hedge — with the cryptocurrency falling 40% from its high set in November last year. 

But Tony Sycamore, a financial markets analyst at the Sydney-based trading platform City Index, says bringing inflation down to 2% is a pipedream.

“I can tell you categorically there is no chance whatsoever that inflation is getting anywhere near 2%; not this year, not next year,” Sycamore said.

Meanwhile, China’s April data shows industrial production, retail sales and fixed asset investment all falling to their lowest point in two years.

The Rhodium report says these numbers and others like them indicate China’s 5.5% real GDP growth target this year is impossible to meet and the more likely growth is at most 2%, and that would depend on a rebound in the second half. 

And the absence of any Shanghai-sized lockdowns.

Because of the sheer size of China’s economy, such a slowdown, while creating problems of its own, could ease inflation pressures around the world, and in turn the pressure on central banks to raise interest rates. That may provide some relief to equities and by extension cryptocurrencies.

Ben Caselin, head of research at cryptocurrency exchange AAX, says Beijing has cracked down on the crypto industry and trading on the mainland, but that doesn’t mean China isn’t influencing markets.  

China’s plan for a central bank digital currency is something for investors to watch because it could act as a stimulus and is part of Beijing’s efforts to de-risk from the U.S. dollar — all interesting developments for gold and Bitcoin, he said.   

“While the U.S. economy and its policies are strongly intertwined with Bitcoin’s price discovery, too often China is left out of the analysis,” he said.