China’s ongoing economic struggles have spurred deflationary forces that have raised eyebrows among economists and are poised to intensify over the upcoming quarters. A series of deteriorating economic indicators in Beijing have cast a spotlight on the nation’s dire economic fundamentals. July’s data, falling short of expectations, has laid bare the predicament. In a disconcerting move, the National Bureau of Statistics halted the release of youth unemployment figures as the numbers soared to unprecedented heights.
The credit landscape hasn’t fared better in July, indicating a marked decline in borrowing demand from both businesses and households. The nation’s colossal real estate sector continues to grapple with persistent issues. Once thriving developer Country Garden teeters on the edge of default, while property giant Evergrande Group sought refuge in bankruptcy protection within the U.S. earlier this month.
A jarring twist emerged as China’s headline consumer price index slipped by 0.3% year-on-year in July, marking the onset of deflation for the first time in over two years. This presents a dichotomous challenge compared to the inflationary concerns witnessed by major Western economies. While a portion of the headline fragility can be attributed to transient factors such as reduced energy and pork prices, the core inflation trajectory has also been dented by the plummeting prices in the shelter and related segments. The cause? The beleaguered property sector.
Implications for Global Economies
The web of interdependence within the global economy weaves connections that extend beyond borders. China’s role as the world’s manufacturer places it at a pivotal junction. As Beijing endeavors to pivot towards a consumption-led growth model and trade tensions with the West remain tense, the reverberations of China’s economic frailty have far-reaching implications. The nation’s economic weakness and the consequential price downturn, especially in producer prices, are poised to cascade into global markets. In a curious twist, this development could aid the Western central banks in their battle against elevated inflation.
In stark contrast to Western economies that emerged from the throes of the Covid-19 pandemic grappling with inflation spurred by restricted supply and resurging demand, China’s narrative unfurls differently. The nation’s transition away from stringent zero-Covid measures, coupled with its robust domestic manufacturing prowess, acted as mitigating factors against supply bottlenecks and moderation in global commodity prices.
However, recent insights presented by Pimco Economist and Managing Director Tiffany Wilding and Pimco China Economist Carol Liao unveil a nuanced perspective. China’s domestic demand has faltered, rendering a landscape of idle capacity. Simultaneously, deleveraging in the property and local government financing sectors has intensified deflationary pressure, shaking the foundation of domestic investment. The outcome? A manufacturing sector riddled with widespread excess capacity.
Fending Off the Onslaught: China’s Response
China’s reaction to this brewing tempest has proven far from comprehensive. Efforts to stimulate and stabilize growth through accessible credit channels, primarily targeted at state-owned enterprises and infrastructure investments, have fallen short in offsetting the weight imposed by the property market turmoil. The ebb in new credit flow into the economy over the past year further accentuates this predicament.
In an attempt to curb the rapid depreciation of its currency, China’s central bank introduced measures on a Friday. However, the market remains unconvinced that these steps are sufficient to reverse the ominous trends. Skylar Montgomery Koning, Senior Global Macro Strategist at TS Lombard, anticipates that market dissatisfaction will persist, expecting fiscal stimulus measures from the government to resemble intensified versions of existing easing measures. This might not suffice to restore confidence in prices, demanding more robust stimuli to rejuvenate sentiment.
The Global Domino Effect
China’s economic condition ripples across the globe, manifesting through various dimensions. Importantly, as a significant force in consumer goods markets, particularly in the U.S., Chinese-manufactured products dominate the landscape. The data from the U.S. Census Bureau, current until June, unveils a 3% average drop in prices of imported goods from China compared to the previous year. Simultaneously, producer prices of Chinese consumer goods slide by 5% in dollar terms. Notably, these price declines cascade onto U.S. consumers. July marked the first instance since the pandemic’s infancy where U.S. consumer retail goods prices witnessed a three-month annualized decline.
This moderation is poised to permeate other developed markets, with U.S. inflation trends traditionally leading the way since the pandemic’s advent. Furthermore, the dimming export figures from China mark a critical juncture. As the risks to Chinese economic growth materialize, potential fiscal policies might aim to stimulate exports. This maneuver could help address a burgeoning domestic oversupply challenge, albeit at the cost of saturating the global market with affordable consumer goods.
The Commodity Conundrum
A common thread in global disinflationary forces stems from commodity prices. China’s colossal demand for commodities positions it as a vital player. Weak domestic investment, coupled with an overarching surplus capacity in manufacturing, paints a stark picture. Notably, sagging sales of new homes and land exacerbate this dilemma. The forecast is dismal, with projections suggesting that Chinese domestic demand will remain insufficient to uplift global commodity demand. This consensus underscores the persisting woes.
Pimco’s Wilding and Liao argue that the downward spiral has only begun to touch global consumer markets, with deep discounting likely to intensify over the upcoming quarters. Amidst this precarious landscape, the longevity and intensity of inflationary pressures rest on China’s forthcoming fiscal policy responses. Adequate stimuli to bolster domestic demand could reignite inflation, while inadequate measures might pave the way for a concerning downward spiral.
The Verdict: Prospects and Ponderings
Persistent deflation in China sets the stage for a global ripple effect. A weaker yuan, coupled with an elevated inventory-to-sales ratio, are set to reduce the cost of Chinese goods abroad. This scenario is anticipated to receive a warm welcome from central bankers in developed markets, providing a much-needed respite.
Uncertainty shrouding China’s recovery trajectory casts a shadow over global markets. European companies, heavily reliant on Chinese demand, find themselves in a precarious position. The nexus between European entities and China underscores the gravity of China’s economic turbulence. While stabilization of China’s economy in the final quarter of the year is a possibility, the journey to this point remains fraught with uncertainties. Market sentiment awaits an upturn in data before fully embracing optimism.
In this interconnected global economy, China’s deflationary quagmire offers a poignant reminder that economic reverberations, much like ripples in a pond, extend far beyond national borders.
