Job adverts are seen at the Lonhua Bus Station, which also serves as a recruitment centre for nearby factories, in Shenzhen on August 9. In the eyes of many international investors, China is on the cusp of a Japan-style “balance sheet recession”. Photo: Bloomberg
Opinion
Macroscope
by Nicholas Spiro
Macroscope
by Nicholas Spiro
Cost of falling prices in China greatly outweighs any benefits for rest of the world
Rather than speculating on the possible benefits of Chinese deflation for other economies, the focus should be on threats to the global economy and markets, plus how Beijing intends to revive growth while maintaining financial stability
At the beginning of this year, many global policymakers worried that the abrupt reopening of China’s economy would boost demand to such an extent that it would pour fuel on the inflationary fire raging across the world.
Kristalina Georgieva, the head of the International Monetary Fund, said in January: “What if the good news of China growing faster translates into oil and gas prices jumping up, putting pressure on inflation?”
Christine Lagarde, the president of the European Central Bank, warned that China’s reopening “will [exert] inflationary pressure on many of us”.
Fast forward seven months and it is clear that these warnings were a colossal misjudgment of the global spillovers from China’s post-pandemic recovery. Instead of fretting about the possibility of China exporting inflation, central banks and governments in advanced economies are coming to grips with its descent into deflation.
While producer prices have been contracting in annualised terms since October 2022, consumer prices dipped into negative territory last month. The timing could not be worse for China which, in the eyes of many international investors, is on the cusp of a Japan-style “balance sheet recession”, exacerbated by concerns over the timeliness and effectiveness of further stimulus measures.
Some economists believe that falling prices in China are good news for global consumers and businesses, and will help central banks in advanced economies bring down inflation. According to data from JPMorgan, Chinese export prices plunged 21 per cent year on year in the second quarter as firms slashed their prices to attract buyers and stay in business.
The strong disinflationary effect on Chinese import prices – which is amplified by this year’s sharp fall in the yuan against the US dollar – is more beneficial to countries with a higher level of trade openness and which are more reliant on Chinese imports, such as economies in Latin America and Southeast Asia.
Yet, as JPMorgan notes, the disinflationary impulse stems from the reopening-induced boost to supply, as opposed to demand. Along with the normalisation of supply chains, this has helped to drive down the prices of global goods. The problem is that the persistence of high inflation in developed economies is down to sticky price pressures in the service sector, one of the reasons that falling prices in China are unlikely to have a major impact in advanced economies.
There are several reasons that the supposed benefits of Chinese deflation for the rest of the world should be treated with caution. First, deflation in China is not pervasive. While the headline rate of consumer prices fell 0.3 per cent last month, the core rate – which excludes volatile food and energy costs – increased by 0.8 per cent. Moreover, spending on services, particularly travel and on eating out, has risen consistently since China reopened.
Second, the global economy has taken a strongly protectionist turn over the past several years. At a time when the United States and Europe’s trade deficits with China are starting to narrow, an influx of cheap Chinese goods would further inflame trade and diplomatic tensions.
Employees work at a wire harness and cable assembly manufacturing company that exports to the United States, in Ciudad Juarez, Mexico, on April 27, 2017. Mexico and Canada overtook China as the largest exporters of goods to the US in the first half of 2023. Photo: Reuters
The diversification of supply chains, moreover, has reduced the amount of goods which the US imports from China. Mexico and Canada were the top two providers of goods to the US in the first half of this year.
Third, Chinese-made goods make up a relatively small share of consumer spending in advanced economies. In the US, housing alone accounts for more than 30 per cent of the consumer price basket. Other key categories that have little to do with imports from China include food and medical care.
Fourth, while prices are falling in China, government bond yields in advanced economies have risen in the past month because of markets’ belated realisation that interest rates will stay higher for longer.
In the US, a persistently strong labour market – wage growth, although it is slowing, is running at almost 4.5 per cent – is pushing up the prices of services. Although increasingly divided over the path for interest rates, the US Federal Reserve is still unsure whether it has raised borrowing costs high enough to quash inflation.
Fifth, and most importantly, the costs of China’s descent into deflation, however temporary, vastly outweigh the benefits for the rest of the world. That China is being compared to Japan in the 1990s so soon after it emerged from three years of self-imposed isolation is deeply troubling and shows how badly confidence in the world’s second-largest economy has been undermined.
Even though comparisons between China and Japan are inapt for the most part, they have made their way into the market narrative around China, fanning fears about global growth just when investors are becoming more concerned about central bank overtightening.
Instead of speculating about the possible benefits of falling prices in China for other economies, the focus should be squarely on China-induced threats to the global economy and markets, as well as how Beijing intends to revive economic growth while maintaining financial stability.
