#TrendingNews Blog Business Entertainment Environment Health Lifestyle News Analysis Opinion Science Sports Technology World News
Can China Save Its Deflating Economy?

Chinese consumer prices have fallen at the highest rate in 15 years, raising concerns about rapid deflation.

Figures released on Thursday show that prices have fallen 0.8 percent in January compared with a year earlier. With the current price contraction worse than many economists’ expectations, this marks the biggest price reduction in 15 years.

At first glance,this might sound like a good thing. Lower prices? Great!

Falling prices, however, or deflation, is terrible for a country’s economy and is symptomatic of low consumer confidence. Deflation reduces the amount of profit companies make, resulting in workers being sacked to cut costs, increasing unemployment. Higher unemployment results in less consumer spending, which reduces prices, worsening the deflationary spiral which gets worse and worse over time.

For an economy, deflation is a worse problem than inflation (an increase in the price level) because over time it significantly reduces economic growth, making people poorer. Deflation also has the unfortunate effect of causing people to hold off on spending until prices fall further. This depresses economic activity even more, resulting in economic stagnation and a decreased standard of living.

This happened to Japan in the 1990s in what is known as “Japan’s lost decade”. A period that saw a significant slowdown in the country’s previously booming economy.

But while in Japan deflation was caused partly by the Bank of Japan raising interest rates to cool down the real estate market, the causes of Chinese deflation are more complex. The primary problem in China is not poor monetary policy but low aggregate demand caused by a real estate slump and years of zero-Covid lockdowns which have damaged businesses and made consumers cautious about spending.

With reduced economic growth and unemployment on the rise, many Chinese workers are seeing their wages decrease. Because deflation causes the value of money to increase over time, the level of inflation-adjusted interest rates in the economy also increases. This makes it harder for companies to service debt costs, reducing investment.

Lower investment over time cripples aggregate demand in the economy, worsening deflation. If this continues then it can lead to economic recession or even trigger a depression as more and more people default on their loans and banks are undermined.

There are already signs that this is happening, with defaults by Chinese borrowers having hit a record high since 2020. Totally 8.54 million people are officially blacklisted by authorities for missing payments on investments. Roughly, the figure is equivalent to 1 percent of Chinese workers.

This will no doubt worsen consumer confidence in China, a country where blacklisted defaulters are blocked from making mobile payments, representing a further drag on the economy. Mobile payment apps such as Alipay and WeChat are the primary way of paying for day-to-day items in China’s big cities.

“The runaway increase in defaulters is a product of not only cyclical but also structural problems,” said Dan Wang, chief economist at Hang Seng Bank China. “The situation may get worse before it gets better.”

The Chinese government has also responded to the crisis by cutting interest rates and vowing to accelerate some infrastructure projects as well as increasing support for the slumping housing market.

Instead of providing optimism and reassurance, however, the attitude of the Chinese Communist Party is that young people should lower their expectations. In response to economic hardship and youth unemployment,President Xi Jinping has ordered young people to “eat bitterness” and embrace menial labor.

Nevertheless, there are signs of market optimism. On Thursday the market demonstrated renewed confidence in the economy, with the Shanghai Composite rising by nearly 1.3%.

“Perhaps markets see the low number as a potential catalyst for more muscular monetary or fiscal stimulus from the central government, which, up until this point, has been moderate in applying countercyclical policy,” said Kyle Rodda, senior financial market analyst at capital.com.

A large stimulus package, however, may be unlikely to materialize due to the Chinese government already having to bail out local and regional governments as well as state-owned enterprises that cannot afford to pay for rising debts.

In December last year, the credit agency Moody’s downgraded its outlook for Chinese sovereign bonds from stable to negative, suggesting a higher risk that the Chinese government will default.

According to the International Monetary Fund, the amount of debt owed by China’s local governments alone stands at $9.3 trillion, which is roughly half of China’s annual economic output. Chinese banks hold trillions more in additional debt that now looks unlikely to be repaid as an increasing number of Chinese default.

Before the ongoing property slump, many local authorities received revenues from rising real estate values and property transactions. With property values falling, however, these revenues have declined sharply.

According to Moody’s, the need for massive government bailouts poses “broad downside risks to China’s fiscal, economic, and institutional strength. The outlook change also reflects the increased risks related to structurally and persistently lower medium-term economic growth.”

On top of all these issues, China’s aging population represents a long-term drag on growth. From 2019 to 2022, the Chinese workforce has shrunk by more than 40 million. Over time this will reduce overall economic output (GDP), as well as tax revenue, making it harder for the government to invest in the economy and provide state pensions for the growing number of retirees.

In 2019 the Chinese Academy of Social Sciences predicted that the main pension fund could run out of money by 2035. But with the economy having significantly declined since then, the Chinese government may run out of money even before then.

According to Zoe Zongyuan Liu, a fellow at the Council of Foreign Relations, it depends on how the economy goes.

“If the economy is not doing well, if investments are not doing well, and the government continues to cut contribution rates, then the deficit problem will worsen,” Liu says.

For now, so long as deflation worsens, it looks as though the debt crisis will also worsen. This will put pressure on the government to grow the economy either through expansionary fiscal policy or through export-led growth.

Considering the debt crisis, the former looks unlikely, while the latter looks set to provoke trade competitors like the US and EU into a trade war with China over key industries.

While this is bad news for China, the falling price of Chinese goods will provide some relief to Western economies struggling to tame inflation. Cheaper Chinese goods, however, will be more competitive on the global market, undercutting other country’s products and putting manufacturers out of business.

This will no doubt increase trade tensions as developed economies continue to suffer the consequences of a chronic trade deficit with China. With the US, UK, EU, and Indian elections coming up this year, expect trade and the economy to be a main issue for voters.


Share This Post On


Leave a comment

You need to login to leave a comment. Log-in