Is China Falling Into a Deflationary Spiral?

Leading thinkers are today debating whether or not China is experiencing deflation.

The Telegraph writes:

It was the third month of deflation in a row ...

However, commentators said accelerating money supply, combined with an enormous surge in bank lending, meant that prices were unlikely to keep falling in the long term and would probably start rising again by the end of the year.

Mish - a leading proponent of the theory that global deflation is the trend for the foreseeable future - believes that China will get dragged down by deflation:

Consumer prices are falling year over year in China. Bear in mind that falling prices do not constitute deflation which is a monetary phenomenon (a reduction in money supply and credit) not a price phenomenon. In this case we see both.

In response to those who argue that China's economy will recover, thus pulling China out of a deflationary spiral, Mish writes:

In regards with China, there is massive overcapacity already. US consumers are still retrenching. Adding to China's productive capacity is exactly the wrong thing to do at this stage. The export model is dead. The Shopping Center Economic Model Is History as well. Thus "stimulus" (here and in China) is guaranteed to fail, leaving still more overcapacity when it does.

Green shoots are a Keynesian mirage.

In other words, Mish doesn't buy that China's economy is going to recover, so he thinks nothing will stop the deflationary spiral.

Nouriel Roubini rounds up what analysts are saying about the issue in an article entitled "What is the Risk of a Deflationary Spiral In China?":

China's CPI [consumer price index] fell 1.5% y/y in April, the third consecutive decline (CPI fell 1.2% y/y in March and 1.6% y/y in Feb). Non-food prices fell 1.5%. April CPI was down 0.2% mom and CPI for January-April was 0.8% lower in Jan-April y/y . Food prices, which comprise one-third of the CPI, dropped 1.3% y/y and 0.8% m/m, dragged down by a 28.6% decline in pork prices due to swine flu a reversal of the 0.5% increase in Q1. (via China Daily)


PPI [producer price index] fell 6.6% in April, the forth monthly decline and the steepest (PPI fell an average of 4.6% in Q109) suggesting further pressure on consumer prices ahead. However the increase in global commodity prices may boost PPI in H2 2009 as base effects from 2008 begin to erode. The sharpest contractions were seen in excavation (-21.5% yoy), raw materials (-10.3% yoy) and manufacturing (-5.4% yoy) but PPI may stabilize in y/y terms in Q3 as government stimulus demand limits deflationary pressure (via Citi)

Chinese CPI peaked in February 2008 on high commodity prices and the year on year declines in such prices will depress prices for several months...

The imput prices index of China's PMI is now increasing (in April)

DBS: current policy directions including the explosive credit expansion in Q1 limit the prospect of a deflationary spiral despite negative headline readings given the explosive credit expansion in Q1. If loose monetary conditions (broad money growth outpaced GDP growth by 7 times in Q1) are sustained for another quarter, they would contribute to inflationary pressures.

[Morgan Stanley]:The initial deflationary impulse due to positive supply shocks should bring about cost savings, especially to energy- and raw materials-intensive sectors. Yet sticky nominal wages will lead real wages to rise, profit margins to fall and employment to be cut back, which along with the effects of past tightening may set off a deflationary cycle with far more serious consequences unless the government can prevent deflationary expectations from getting entrenched.


[United Overseas Bank]: The rebound in the global commodity prices from a bottom has translated into higher input prices for China’s manufacturers (reaching 50 in the CFLP PMI for the first time since Aug 2008), which reduces deflationary pressure and can revoke re-stocking. inflation may come back earlier than expected and investment may have a more positive contribution to the economy ahead.


Goldman (via WSJ) CPI growth was negative in month-on-month terms for 7 months through February suggesting that China entered deflation before February 2009

The disinflation has been to a large degree driven by the weak real estate market (Danske)

The moderation in PPI for consumer goods is more modest than overall numbers, suggesting deflationary pressure is not yet broad-based. Despite the downward trend in PPI, prices of some goods (steel) have rebounded on the stimulus plan and post-winter rollout may boost prices (UOB)

What do I think?

Well, as I've written for some time, I think that we are experiencing global deflation, but that - at some point - it will give way to runaway inflation.

Moreover, given that this could be worse than the Great Depression, it is important not to underestimate the deflationary forces at work.

Remember that the bubble was not confined to the U.S. There was a worldwide bubble in real estate. The Economist magazine wrote in 2005 that the worldwide boom in residential real estate prices in this decade was "the biggest bubble in history". The Economist noted that - at that time - the total value of residential property in developed countries rose by more than $30 trillion, to $70 trillion, over the past five years – an increase equal to the combined GDPs of those nations.

The housing bubble has certainly burst in China. Housing bubbles have also collapsed in France, Spain, Ireland, the United Kingdom, Eastern Europe, and many other regions. And the bubble in commercial real estate is also bursting in China, as well as globally (see this).

On the other hand, the printing of trillions of dollars by governments around the world - including China - could turn into an inflationary hurricane at some point.

Because China has a command and control economy - where the government can order prices of goods, stocks or anything else to go up and down at will - it presents a special situation. For example, as Bloomberg writes today:

China’s government is so eager to get shoppers to spend that it’s using subsidies and tax cuts to slash the prices of some 20 consumer products, including cars, motorcycles, computers and mobile phones. In Shanghai and other major cities, local officials are even handing out shopping vouchers. “We need to vigorously expand domestic demand, including consumer demand,” Wen told the National People’s Congress.

Therefore, we ultimately have to defer to China experts like Michael Pettis to determine whether or not China will get dragged down into a deflationary spiral.