Troublesome Deflation Hits China’s Economy

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China is bucking the global trend by grappling with a persistent problem of deflation as other major economies struggle with high inflation. In July, China experienced a 0.3% year-on-year decrease in consumer prices, marking the first negative reading since February 2021. Meanwhile, producer prices have been plunging since late last year, with a significant 4.4% decline last month.

The woes facing Beijing extend beyond depressed manufacturing activity and consumption. Despite initially enjoying an economic boost from the lifting of strict COVID-19 lockdowns, China has witnessed a stark 10% drop in export prices, the most substantial decline in over a decade. The International Monetary Fund (IMF) has raised concerns about China “losing steam,” highlighting challenges faced by its labor market and real estate sector.

Notably, youth unemployment in China spiked to an all-time high of 21.33% in June. Moreover, property giant Country Garden Holdings has recently missed two debt payments, further underscoring the country’s property market woes.

Comparisons are being drawn to Japan’s experience with deflation, fueling speculation that China may also endure a prolonged period of falling prices. However, the pain could be more severe for China due to mounting trade restrictions and its substantial debt burden. Despite Beijing’s efforts to shift its economy towards domestic consumption and reduce reliance on exports, these measures have not been successful. Economist Edward Yardeni, president of Yardeni Research, points out that China’s trade partners have become increasingly frustrated.

The repercussions of China’s deflationary trend are likely to extend far beyond its borders. Eswar Prasad, an economics professor at Cornell University and former China division chief at the IMF, anticipates that weak household demand and excess capacity in certain areas of Chinese manufacturing will reverberate globally. As such, it is evident that the impacts of China’s economic developments will ripple throughout the world economy.

China’s Deflation and Its Impact on U.S. Inflation

China’s deflationary trend is expected to alleviate concerns over inflation in the United States and Europe, according to Thierry Wizman, a global foreign-exchange and interest-rate strategist for Macquarie. The reduced demand from China eases pressure on global supply chains, while the decline in manufacturing prices could lead to lower prices for Chinese goods paid by American consumers.

However, the impact on U.S. inflation is likely to be limited, considering that the U.S. consumer price index is heavily influenced by factors such as housing, food, energy, and healthcare prices, which are not heavily reliant on Chinese imports. Economists speculate that the deflation in housing costs, especially falling rents, will have a significant impact in reducing U.S. inflation in the coming months.

Moreover, the effects of China’s deflation on the U.S. economy are expected to be minimal due to strong domestic demand in America. Additionally, the share of U.S. imports from China has decreased in recent years, with Mexico surpassing China as the top U.S. trading partner.

Nevertheless, the U.S. is starting to see signs of Chinese deflation reflected in producer price index (PPI) inflation rates. According to Yardeni, there is a notable correlation between Chinese and U.S. PPI for finished goods.

While China’s current deflation situation is regarded as “serious but not dire,” David Dollar, a senior fellow at the John L. Thornton China Center, emphasizes the importance of addressing real estate reform in China. Dollar suggests implementing measures that address unviable developers, promote the auctioning of empty apartments, and encourage the completion of units that have already been paid for. Failure to address these issues may lead to a larger real estate crisis in China with reverberations felt worldwide.

In conclusion, while China’s deflationary environment is expected to have limited impact on U.S. inflation, addressing real estate concerns in China remains critical to avoid potential global consequences.

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