Deflation Becomes a Threat to China’s Economy

The United States has spent much of the past 18 months struggling to control inflation. China is experiencing the opposite problem: People and businesses are not spending, pushing the economy to the verge of a pernicious condition called deflation.

Consumer prices in China, after barely rising for the past several months, fell in July for the first time in more than two years, the country’s National Bureau of Statistics announced on Wednesday. For 10 straight months, the wholesale prices generally paid by businesses to factories and other producers have been down from a year earlier. Real estate prices are tumbling.

Those patterns have amplified concerns about deflation, a potentially crippling pattern of broadly falling prices that tend to also depress the net worth of households — as it did in Japan for years — and make it very hard for borrowers to repay their loans.

Deflation is particularly serious in a country with very high debt, like China. Overall debt is now larger in China, compared with national economic output, than in the United States.

The Chinese government has pressured economists inside the country not to mention the possibility of deflation, while publicly denying that deflation poses any risk.

“Generally speaking, there is no deflation in Chinese society and there won’t be in the future,” Fu Linghui, a National Bureau of Statistics official, declared at a news briefing on July 17.

But economists are concerned.

It has been nearly eight months since China’s top leader, Xi Jinping, relaxed stringent anti-pandemic measures that had paralyzed many parts of the economy. After exhibiting bursts of energy early this year, the Chinese economy, the world’s second largest, has started to slow. Economic policymakers are under increasing pressure to step in to help revive growth, something they have signaled a readiness to do but have not yet carried out in a meaningful way.

“The Chinese economy is squarely facing the specter of deflation, increasing the urgency of government measures to stimulate the economy and, perhaps more importantly, steps to rebuild household and business confidence,” said Eswar Prasad, an economics professor at Cornell University and former China division chief at the International Monetary Fund.

The prospect of sustained deflation only adds to China’s difficult problems when geopolitical tensions are driving the United States and other key economic partners like Germany to seek alternatives to China as a primary source of manufactured goods.

A weak appetite for Chinese goods from domestic and foreign buyers alike, demonstrated by a steep slide in exports this summer, represents a challenge for China, said Wang Dan, the chief economist at Hang Seng Bank China. Low exports are “driven by both slowing demand from the developed world and an effort to diversify supply away from China,” she said.

Consumer prices were down 0.3 percent in July from a year earlier. They were pulled down by declining food prices — particularly for pork, a staple of the Chinese diet — and falling car prices, the result of a price war and heavy discounting in the auto industry.

Some measures of consumer prices, such those as for clothing, shoes and particularly health care, still showed small increases.

But producer prices declined 4.4 percent last month from July 2022, as weak demand has forced factories and other businesses to cut prices.

Perhaps most worryingly, particularly in a country where three-fifths of household assets are tied up in real estate, housing prices are falling.

According to the Beike Research Institute, a Tianjin firm, prices of existing homes in 100 cities across China have fallen an average of 14 percent from their peak in August 2021. Rents have fallen 5 percent.

Prices for new homes are much harder to assess. Official data shows smaller price declines for new apartments, but local governments have put heavy pressure on developers not to cut prices. That has prompted developers to pursue strategies like offering free parking spaces and other discounts, effectively pulling down the overall price of the home in ways that may not be readily reflected in government data.

The standard remedy for deflation is for the government to pump up the money supply, notably by encouraging banks to lend more. But not a lot of companies or households have shown much interest lately in borrowing, with the exception of state-owned enterprises, which are under instructions from government agencies to continue borrowing and investing even in projects with low returns.

China avoided broad deflation in early 2009, when prices fell during the global financial crisis, and again in 2012, when it also faced weak foreign and domestic demand. But rescuing the economy was easier then. Real estate prices have soared over the past decade, as China’s central bank has pumped out vast sums to keep the economy growing briskly and also to prevent the country’s currency, the renminbi, from becoming strong enough to undermine the export competitiveness of the country’s factories.

Last week, Chinese officials called on local and provincial governments to enact a series of measures to encourage consumers to spend. But the central government has been reluctant to pay for more consumer spending.

That caution has prompted economists outside mainland China to question whether the recent steps will make much of a difference.

“It’s like a high school principal exhorting his students to do better, rather than a measure to support economic activity,” said Andrew Collier at Orient Capital Research in Hong Kong.

Adam S. Posen, the president of the Peterson Institute for International Economics in Washington, attributed China’s current economic weaknesses to Mr. Xi’s extreme response to Covid. In an article last week in Foreign Affairs, Mr. Posen called the phenomenon “economic long Covid.” Consumer confidence suffered lasting harm from municipal lockdowns, mass testing and the forced removal of very large numbers of people to specially built quarantine camps.

But China’s economic troubles have been building for several decades. China has relied lopsidedly on investment and exports since the early 1990s, while holding down wages and restricting the investment options of Chinese households so that they have had little alternative to putting money into new houses and factories.

Now China faces a very long expected glut of both. At the same time, the birthrate has plummeted and youth unemployment has soared. So new apartments — and the appliances and other accouterments of starting a home — are neither needed nor affordable for many people.

Li You contributed research.

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