China’s path to becoming the world’s economic leader has started on the wrong foot. The crisis that the Asian giant has been going through in recent years is not abating, with the real estate sector in the spotlight and, at the same time, the Chinese economy is suffering a deterioration that the authorities are unable to remedy. Price growth has stagnated in the country and has already accumulated 5 consecutive quarters of contraction, a trend that analysts say will not be able to reverse in the coming quarters. The rumor of an entry into a situation of deflation, similar to that experienced by Japan in recent decades, is spreading, and there are already respected voices in China, such as the former governor of the central bank, Yi Gang, who They acknowledge the danger of deflation, a spiral of falling prices and wages and stagnant growth from which it is very difficult to escape. Japan is a good example of this.
Deflation is one of the cursed words for any economy in crisis. The great danger of entering a deflationary situation is the risk that the situation becomes chronic, and that it becomes a trend that feeds on itself and from which it is very difficult to get out. When prices begin to fall continuously, many consumers decide to postpone their purchases, especially those that involve higher expenses. Why buy a car this month, if every month a new drop in prices is confirmed? The logic followed by many citizens is to wait for prices to continue to fall, and this becomes a self-fulfilling prophecy that is very difficult to reverse. The lack of demand pushes producers to continue to lower prices and wages, etc.
This has become the main danger that China will face in the future, and it jeopardizes the trend that could make the country the first economy on the planet in the coming decades, ahead of the United States. The trigger that generates the fear of deflation is the real estate crisis that the country is going through, which is not completely resolved despite the efforts of the authorities and increasingly recalls the crisis that Japan experienced in the 1990s, which led to the so-called “lost decade” for China’s neighbor. Beijing is failing to achieve the 5% growth target that it had set for itself this year and is gradually moving away from the 6% levels that, a few years ago, constituted the minimum growth that the government aspired to maintain.
The crisis that Evergrande triggered in 2021, and which ended with its liquidation this year, was the demonstration of the imbalances generated in the country, after a few years of meteoric growth of the Chinese economy and stock market that positioned the country as the main promise of global economic growth and leadership outside the American orbit. The situation has changed very quickly: signs of deflation are accumulating in China, and this is beginning to appear as the main risk for the country. The consumer confidence indicator is close to its historic lows, and more and more households recognize that they are more oriented towards saving than towards consumption.
A trend that will continue at least until next year
This Monday, China released its latest inflation data, and these, as has been the norm in recent months, were once again below analysts’ expectations. The 0.6% in August is below expectations, despite being boosted by food prices, one of the few variables in the basket that still see increases above 2%.
The weak inflation in August is an additional piece of information that adds to the negative trend in the GDP deflator, one of the most closely watched indicators for understanding price developments in an economy. The GDP deflator has now accumulated five consecutive quarters of decline, and many analysts are confirming their forecasts that it will continue to move in negative territory in the coming quarters.
The economist of BloombergEric Zhu believes that the GDP deflator will remain negative until next year. The agency also gathers the opinion of Jacqueline Rong of BNP Paribas, who expects the trend to continue next year, and that of other experts, such as Xing Zhaopeng of ANX, Arthur Budaghyan of BCA Research or Robinn Xing of Morgan Stanley, who all point in the same direction.
If those forecasts ultimately pan out, it will mean China will have the longest streak of consecutive quarters with a negative GDP deflator since records began in 1993. “We are definitely in deflation and probably entering the second stage of the process,” said Xing, chief China economist at Morgan Stanley. “Japan’s past experience suggests that the longer deflation lasts, the more stimulus the government will need to inject into the economy to pull it out.”he emphasizes.
Current stimuli will not solve the problem
Fears of entering a deflationary situation have reached the highest levels in the country. Former Chinese central bank governor Yi Gang had words last week to evoke this danger. For Gang, combating the risk of disinflation must now be a priority for the authorities, considering that “fiscal measures and an accommodative monetary policy” are necessary, and that the government should “focus on combating deflationary pressures”, and instead return the deflator to positive territory as soon as possible, a message that echoes the view of the Morgan Stanley economist.
And the problem is that China is not facing the danger of a deflationary spiral with the stimulus measures it has taken so far. In an economy subject to strict government control and heavy state intervention, the stimulus policies adopted by Beijing in recent years to deal with the crisis have focused on the supply side. Supporting the country’s large real estate conglomerates with billions of dollars of injections, or local banks to provide liquidity, is a crutch for the supply side, and it can even worsen the deflationary situation of an economy, because it supports the supply side, but if the economic health of consumers does not improve, a disinflationary imbalance between supply and demand can arise. With more supply and weak demand, prices tend to fall. This may be one of the reasons why Yi Gang is now calling for stimulus measures to stimulate demand in order to combat deflation.
There is also an additional element at the moment in China that could contribute to worsening the situation the country is going through. Expectations of a deflationary situation, which could end up forcing the central bank to increase its stimulus measures, have led investors to buy Chinese bonds on the market, bringing these bonds to new historical lows of yield, below 2.5% in the case of the 10-year benchmark index. , and these low levels can make markets fear for the health of the country’s banks, if they have taken excessive rate risk (an exposure to assets that have appreciated excessively and that, if their valuation were deflated, could generate holes in the banks’ balance sheets, as happened with SVB, the entity that went bankrupt last year in the United States.
Japan, the example to avoid
What has happened in Japan in the last 30 years is the mirror that no one wants to look at themselves in. After becoming one of the world’s economic miracles after World War II in the second half of the 20th century, Japan had to face the bursting of the real estate bubble and the collapse of the country’s financial markets in the 1990s. To get an idea of the stagnation of the country’s stock market, the 38,000 points that the Japanese Nikkei 225 index exceeded in December 1980, and which marked the ceiling of the Japanese stock market, were not recovered until 2024. The Chinese value The market, for its part, is suffering the consequences of the crisis and since 2021 has been following a trend that has taken away more than 45% of its capitalization, three disastrous years for investors in the Asian giant.
The problem for China is that there are some worrying parallels with Japan: the bursting of a real estate bubble after years of unusual growth, or the aging of the populationan element that also plays an important role in this puzzle. Aging populations tend to consume less and save more, which is now playing a negative role for China in its fight against deflation. China is beginning to suffer from a demographic problem also associated with stagnation and deflation, and in 2023 it recorded, for the first time in over 60 years, a decline in its population.
