China Faces Deflation as Prices Fall
China, the world’s second-largest economy, is currently grappling with deflation as prices fell by 0.3% in July compared to the previous year. While the term ‘deflation’ is not officially coined until prices have fallen for three consecutive months, there are concerns that China is heading in that direction. Deflation is a phenomenon that worries governments and central bankers even more than inflation, as it can erode business profits, depress confidence, discourage investment, and lead to job losses and high unemployment.
The causes of China’s deflation are complex, but the key factor is a post-pandemic decline in consumer activity and confidence. During the height of the pandemic, Chinese businesses thrived due to high global demand for medical supplies and online goods. However, as foreign demand decreased after reopening, domestic demand did not bounce back as expected. Chinese consumers’ confidence was severely damaged by the pandemic, with businesses closing and savings depleted during lockdowns. This lack of confidence has led to reduced spending and a decline in domestic demand.
Another contributing factor to China’s deflation is the previous ‘over stimulus’ of the economy. Massive subsidy packages and borrowing to invest in the wake of the 2008 financial crash led to a decade of mass production and construction. As a result, the Chinese economy now finds itself with an excess of goods and properties, as well as significant debt burdens. The property market is also in crisis, and one in five young people are unemployed, posing a major economic challenge for China.
China’s economy is closely linked to global supply chains, and deflation would make Chinese goods cheaper, undercutting foreign companies. However, there would also likely be a drop in Chinese demand for foreign imports such as food, energy, and raw materials, which would negatively impact countries like the UK.
China’s leaders are concerned about the potential economic consequences of deflation. Economic success is a key pillar of legitimacy in China’s one-party system, and a situation where people feel they cannot progress in life poses a challenge to the system. While there have been small-scale stimulus interventions, a larger stimulus package may not be desirable or fiscally feasible. Many experts believe that small tweaks will be enough to address the situation, and it’s important to note that the Chinese economy is still growing, albeit slowly.
Despite some positive signs in the data, such as month-on-month price growth and Core CPI growth, there is no doubt that China is entering a period of economic jeopardy. The impact of China’s deflation will not only be felt within the country but also globally, given its interconnectedness with global supply chains.
Overall, China’s deflation poses significant challenges for the economy and requires careful attention from policymakers to prevent further economic downturn.