Andrew Sheng and Xiao Geng urge China's leaders to respond to rising global energy prices by fighting deflation at home

By Andrew Sheng and Xiao Geng

As the wars in Ukraine and Gaza show, energy markets are highly vulnerable to geopolitical developments. At the same time, energy is the main driver of global geopolitical competition – a point that Helen Thompson of the University of Cambridge has often highlighted. The rivalry between the United States and China is no exception.

The relationship between energy and geopolitics came to the fore during the Industrial Revolution. Western countries harnessed wind, coal, and steam power to increase productivity sharply and achieve unprecedented prosperity at home, while colonising faraway lands and appropriating their resources. It was control over energy that enabled the West to consolidate its economic, political, military, and scientific dominance over the rest of the world.

Geopolitical competition has since amounted essentially to a fight over human capital and natural resources – especially energy resources. For Germany and Japan, World War II was partly about securing vital oil resources in southeastern Europe and Southeast Asia, respectively. A number of other conflicts – from the two Gulf Wars to Russia’s current war against Ukraine – can be considered largely energy wars.

Energy has been a pillar of US global hegemony. The discovery of oil resources in the nineteenth century helped to propel America’s rise as an industrial power. The creation of the petrodollar system in 1973 – when the US and Saudi Arabia agreed that oil would be priced and traded in dollars – was another boon for US global dominance. The shale boom, which began in 2010, cemented America’s energy supremacy.

All of this means that America’s “exorbitant privilege” is even greater than that enjoyed by other reserve-currency countries. The US can not only service its foreign debt, but also pay for all of its imports, including of oil (though it has plenty of its own), in its own currency. Other economies that issue reserve currencies – such as China, the eurozone, and Japan – can also do so to some extent, but they still must operate within the petrodollar system, and they remain major oil importers.

China’s rise, by contrast, has entailed an energy dilemma. Despite vast coal reserves, China has always been vulnerable on the energy front – a weakness that became apparent when the US imposed a trade embargo on China in 1950, during the Korean War. China managed to find ways around this vulnerability during its decades of rapid growth and industrialisation: since its 2001 accession to the World Trade Organisation, the country has met its rapidly growing energy demand with imports. But climate change, combined with recent geopolitical tensions, have complicated matters considerably.

China became the world’s largest carbon dioxide emitter in 2006. But it has gradually changed its energy mix over the years, first to reduce pollution and then, more recently, to advance net-zero-emissions goals. In 2016, Chinese natural-gas consumption took off, and in 2021, Chinese imports of liquefied natural gas increased by 15% year on year, making China the world’s largest LNG importer.

Renewables – such as solar, wind, hydro, and nuclear – have also increasingly featured in China’s energy mix, not only to increase environmental sustainability, but also to boost energy security by reducing dependence on foreign oil and gas. Efforts to diversify sources of fossil-fuel imports further reflect China’s commitment to increasing its energy security – an imperative that deteriorating relations with the US have made even more urgent.

Now, higher energy prices are putting still more pressure on China. Since the Ukraine war began, China – like India and other economies in the Global South – has benefited from deep discounts on energy supplies from Russia. But global energy prices have been climbing. From May to September last year, West Texas Intermediate crude oil prices rose from $67.6 to $90.8.

Though oil prices subsequently receded slightly, BP’s latest Statistical Review of World Energy predicts that energy prices may well continue to rise this year. In fact, from December 12 to January 12, the natural-gas futures price index surged from 2.1 to 2.7, driven partly by the escalating war in Gaza.

At a time when China is grappling with deflation – over the last two years, the producer price index dropped from 110 to 97, and the consumer price index fell from 101.5 to 99.7 – an energy-price spike is the last thing it needs. The combination of rising global energy prices and Chinese deflation could well undermine corporate profits, weakening investment, and might also spur China’s trade partners to double down on protectionist policies. Already, the European Commission has launched an anti-subsidy investigation into Chinese battery electric vehicles, setting the stage for possible “anti-subsidy” duties on Chinese BEVs.

Renminbi depreciation could add fuel to the protectionism fire and is already causing capital outflows to rise. Over the last year, as the renminbi’s dollar exchange rate has depreciated from 6.7 to 7.17, $84.5 billion (net) has exited Chinese stock and bond markets – a 44% increase compared to 2022.

Meanwhile, GDP growth continues to slow. With the rest of the global economy also struggling to achieve strong growth, the risk is rising that a vicious cycle will begin, with slowing global growth (and, thus, falling global demand) exacerbating China’s own slowdown and undermining global growth further. As higher energy prices fuel inflation globally, a period of stagflation in many parts of the world could follow.

China cannot singlehandedly lower global energy prices, but it can tackle deflation at home. A virtuous cycle of domestic and global growth is within reach. After years of maintaining a conservative macroeconomic policy stance, the time has come for China to launch a new round of fiscal and monetary expansion. This would go a long way toward increasing the private sector’s confidence – and willingness to invest – thereby reversing the deflationary trend and boosting growth in China and the rest of the world.

Andrew Sheng, is a distinguished fellow at the Asia Global Institute at the University of Hong Kong. Xiao Geng, Chairman of the Hong Kong Institution for International Finance, is a professor and Director of the Institute of Policy and Practice at the Shenzhen Finance Institute at The Chinese University of Hong Kong, Shenzhen. Copyright: Project Syndicate, 2024, published here with permission.