Consumer prices in China have been falling, now that usually sounds like a good thing, and a lot of times it is but many economists are indicating that China is headed towards a period of deflation, often an even worse scenario than rising inflation.
Before addressing that point let’s first understand what deflation is.
Imagine you live in a world where prices are constantly falling. This situation is called deflation. It’s like going to the store and finding out that the things you want to buy are cheaper than they were before.
Now, on the surface, this might sound like a good thing because you can buy more with the same amount of money. However, deflation can have some drawbacks. When prices keep going down, people might decide to delay their purchases, thinking that things will get even cheaper in the future. This can lead to businesses not selling as much, which might cause them to cut production and reduce jobs.
If businesses are making less money and people are losing their jobs, it can create a kind of economic slowdown. This is because when people are not spending as much, businesses are not making as much, and the cycle continues.
Also, deflation can make it more challenging for people and businesses to pay off debts. If the value of money keeps increasing, the amount you owe on a loan might become more difficult to repay because your income will not be growing at the same rate.
To understand further what is going on in China let’s dive into Japan’s recession in the 1990’s:
Many call it the lost decade, in the 80’s Japan’s economy was booming. The real estate and stock market were doing better than ever and there was a sense of optimism in everybody’s mind. However, that party was over in the early 90s when the stock market burst, prices fell, and the economy was sent into a deflation spiral. However, it is noteworthy that in Japan’s case, the working-age population growth was in the negative, so they didn’t have to face unemployment. The Bank of Japan tried continuously to stimulate economic growth by cutting interest rates and printing money but none of that seemed to work very well. It took 34 years for their stock market to record a new high and their GDP per capita has lingered around forty thousand US dollars ever since.
It’s hard to say if Japan’s long-lasting deflation era was the reason for its slow economic growth but one thing is for certain, the longer it lasts the harder it is to escape it.
That is what economists are worried is happening to China.
China’s GDP per capita grew about 5% last year, this is China we are talking about, and that’s not too great for their standards. Like Japan in the 90’s China is also facing a real estate bust.
Why?
Well, the Chinese government suggested there was too much debt building up and they tried making it difficult for commercial investors to get their hands on external funding. That happened in 2020 and since then the real estate market has been declining.
Due to that decision, Chinese households are seeing their house valuation drop, leading to a decrease in spending habits. But unlike in Japan’s case, the housing market is falling far slower.
Now that doesn’t make financial sense, the whole economy is dealing with various issues. Why isn’t the housing market feeling its fair share of pain? Many economists are speculating that various local governments within China are inflating the housing prices manually. However, the only way to overturn the crisis is to allow the house’s value to fall giving Chinese residents a chance to buy back that real estate.
Why is China’s deflation a worldwide issue?
Fragile consumer spending in China leaves exporters no choice but to source buyers overseas and that has led to China’s export prices falling as well. You might be asking yourself isn’t that a good thing? Yes, for the consumer but for domestic suppliers this brings them enormous pressure since China can always supply products far cheaper.
For example, in the space of electric vehicles, China is lapping its competition by producing far more cars, much cheaper, and selling them all over the world increasing the chokehold on its market share. That is why the US has imposed various trade barriers against Chinese exporters.
What is the Chinese government planning to do to resolve the issue?
During the country’s legislative session in March, Premier Li Qiang proposed the issuing of treasury bonds in an attempt to stimulate economic growth although many investors are doubting it will help.
These bonds are usually reserved for economic emergencies. In the past 25 years, this will be the 4th time China has issued such a bond. The reason we should worry is because the past 3 bonds issued by the Chinese government led to a severe financial crisis which can only mean the government is concerned by the economic trend.
We can only hope China has studied Japan’s deflation crisis in the 90’s. Back then Japan was the second largest economy in the world, thirty years later China is facing similar issues and happens to be in the same financial power as Japan was back then, holding on to that second place as we speak. However, if the trend continues this can, and will lead to massive losses in the world’s economy. The only thing we can do now is educate ourselves and hope for the best.
Author: Θανάσης Ντάτσης
Sources:
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Deflation and default haunt China’s economy: The Economist
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China consumer prices plunge at fastest rate for 15 years as deflation fears deepen: The Guardian
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China’s Deflation: Another ‘Tell’ Of Serious Economic Trouble: Forbes
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China’s deflation problem keeps getting worse: Business Insider
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In China, Deflation Tightens Its Grip: The Wall Street Journal
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China to Issue CNY1 Trillion in Special Ultralong Bonds This Year: MarketWatch
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China’s Ambitious Growth Plan Leaves Investors Wanting More: Bloomberg
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The Lost Decade: Lessons From Japan’s Real Estate Crisis: Investopedia
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Deflation: Definition, Causes, Changing Views on Its Impact: Investopedia