Liam Dann: How China's Omicron showdown will cost Kiwis in inflation fight

Medical workers headed to Shanghai gather near a banner which reads: 'Unite as one, resolutely win the battle against epidemic prevention and control'. Photo / AP

OPINION:

One of these Sundays this column will be full of good news about the global economy clicking back into balance, supply chains opening up and prices for consumer goods coming down.

But not this Sunday.

No, this week it's more grim tidings of inflationary mayhem, more reasons why your grocery bills and mortgage payments are going up. Good times.

At least this column comes with scenes from an exotic location - like a very dry James Bond film.

The location is Shanghai, the mega-city of 25 million people, now in the grip of an extreme lockdown as officials there seek to maintain a policy of zero-tolerance for Covid.

Normally, Shanghai is incredibly busy, full of energy and constant momentum.

Shanghai was also, at least until a few years ago, a city less constrained by the austere gaze of the Chinese Communist Party.

An officially designated free-trade zone, it was a place where wealth and capitalist decadence were displayed openly and brazenly.

It put New York and London in the shade.

Central streets were gridlocked with Bentleys and Lamborghinis. Digital billboards for luxury brands like Prada and Gucci coloured its futuristic skyline.

The lockdown of Shanghai, and other big Chinese cities like Shenzen, is bad news for those of us hoping the world's inflation pressures will ease any time soon.

Crucial hubs for global trade, ports in Shanghai and Shenzen are grinding to a halt as Covid restrictions bite.

The situation is an absolute trucking mess.

The vast fleet of trucks that supply Shanghai with goods from across mainland China has bottle-necked at Covid testing stations on provincial borders.

These are the trucks that pick-up imports from Shanghai's port, where containers are now piling up and throwing already disrupted global shipping schedules further out of whack.

Stories of extreme measures to control the spread of Omicron read like something from a dystopian sci-fi film - crying children separated from parents, armies of PPE clad medics arriving from around the country.

Of course, it's a bit rich to be sitting here in a former hermit kingdom arguing China just needs to get on with it and open up.

In New Zealand, we maintained a zero-Covid response up until it was clear we couldn't, but it was also a highly political call.

There are plenty of people who think we waited too long and plenty who think we gave up too soon.

In China, there is little room for public debate, with one man firmly in charge.

But the extreme measures have prompted more questioning of Beijing than usual.

That's got some Western media interested, like Bloomberg News suggesting this could become the biggest crisis of President Xi Jinping's tenure.

Xi and the Communist Party have isolated their way into a showdown with Omicron that threatens to show up the limits of state power.

In that context, you can be sure that inflation concerns in New Zealand - or anywhere else in the West - don't figure high on President Xi's priority list.

We should expect shipping costs to rise or at least remain at elevated levels for longer.

That means higher prices for all sorts of goods from electronics to cars and to furniture and clothing.

There is no easy way out from here.

Some analysts argue that if Omicron gets a hold in China, causing anything like the disruption it did through the US, then we'd see even more disruption and an even bigger supply shock fuelling inflation.

Workers in PPE unload groceries before distributing them to local residents under the Covid-19 lockdown in Shanghai. Photo / AP

It's not a simple equation.

Perversely, the lockdown is also curbing Chinese demand for fuel and putting some downward pressure on oil prices. It risks slowing Chinese economic growth, which would also put downward pressure on global demand for commodities.

But the net effect is probably not good.

Somewhat inevitably, it all leads us back to the big economic question of the year: can we beat inflation without going into recession?

Ultimately, inflation is all about supply and demand being out of balance.

Covid disruption - and now war and sanctions against Russia - suppressed supply in the global economy.

Meanwhile, the pandemic didn't collapse demand as feared. Central bank measures to head off an expected collapse in demand have actually boosted it.

Having spent the past 18 months hoping that supply issues would resolve themselves, central bankers now accept they have no choice but to adjust the only part of the equation they can control - demand.

So interest rates are rising and the money supply is being contracted with a view to making us all feel poorer and consume less.

Monetary policy, as the central bankers are fond of saying, is a very blunt tool.

There's no doubt it has the ability to clobber inflation but whether it can do it without squashing demand and causing a recession is another matter.

This week we'll get more insight into the Reserve Bank's inflation-fighting strategy.

Wednesday's Monetary Policy Review is sure to see the official cash rate rise. The market is divided on whether it will rise by 25 basis points or a more aggressive double shot of 50 basis points.

Is it better to whack the economy harder and sooner at risk of flattening demand and causing a recession?

Or is it better to deliver a series of more gentle taps at risk that consumers don't pay attention until it is too late?

There are no easy choices.

Whichever way the Reserve Bank goes this week, the scale of global events right now is a reminder of the limits to our local influence.