China: will the rest of the world feel the pain of deflation? – 08/17/2023 – Market

Beijing’s economic woes worsened last week after it emerged that China had slipped into deflation. The news highlights how the country is struggling to live up to expectations of a strong recovery after emerging from prolonged Covid lockdowns.

But will the fall in prices have an impact beyond Chinese borders, in places where the greatest risk is still that the long period of high inflation will continue?

For now, economists say there is little cause for concern, as:

Chinese deflation will likely be temporary

Deflation is especially worrisome when it is widespread and caused by companies desperate to sell to consumers who are unwilling or unable to buy because they are struggling.

This describes neither China’s economy nor its price movements.

The economic recovery after reopening has been disappointing – real estate remains a major concern – but output continues to grow and is forecast to expand by almost 5% for this year.

“China’s consumption recovery remains smooth and uneven, but it is a far cry from Japan-style deflation,” said Duncan Wrigley, chief China economist at Pantheon Macroeconomics, referring to the country’s decades-long experience with prices at fall.

While Chinese consumer prices fell 0.3% in the year to July, a small drop in costs has also occurred in 2021. Now, as then, the deflation looks temporary – more the result of underlying effects than deep-seated problems.

In July alone, prices rose by 0.2%, and increased by 0.5% in the first seven months of 2023. The measured deflation came about because prices –mainly for pork, which has fallen 26% in the last 12 months– have not increased in the Same pace as 2022, when China went through several major lockdowns.

Neil Shearing, chief economist at Capital Economics, said the rise in core inflation – which excludes food and energy and is considered a better measure of underlying price pressures – from 0.4% in June to 0.8% in July demonstrated the lack of consolidated deflation in China. “To the extent that chronic demand weakness shows up in the inflation data, it will show up in the headline numbers,” he said.

Inflation is rarely as contagious as it seems.

The world – except China – seems to have suffered an inflationary boom in the last two years. While the pace of price increases has been high in most countries, the reasons differ markedly.

Price increases brought on by bottlenecks in global supply chains may have been universal. But they have been amplified in the US by extremely strong growth in consumer demand. The surge in demand came after a huge fiscal expansion in 2020 and 2021, when the Trump and Biden administrations sent large checks to families to fight the Covid-19 crisis.

Strong demand was much less of an issue in Europe and emerging economies. These suffered much more from Russia’s invasion of Ukraine. In Europe, the tightening came from rising natural gas prices. In poorer countries, higher food prices and energy costs caused a broader rise in the price level.

Paul Donovan, chief economist at UBS, said that in the case of Chinese deflation, price pressures were likely to prove “intensely local”.

While the price of Chinese imports is likely to drop as a result of the country’s economic woes, Donovan noted that “a lot happens” to exports before they reach their final destination. “Usually most of the price of something made in China and sold in the United States will be paid to American workers — in transportation costs or advertising, etc.”, he said.

Chinese deflation could help in Europe

The big problem with inflation, especially in Europe and emerging economies, has been the higher cost of imports, lowering the standard of living and triggering a process in which domestic companies try to defend their profit margins by raising prices, and workers struggle to reach them.

Chinese industrial goods prices fell 4.4% in July from a year earlier. To a lesser extent, this has an effect abroad.

European countries will benefit from a weaker Chinese economy, which poses less competition for natural gas supplies, as it adjusts to ditch Russian supplies.

It would be wrong, of course, to suggest that everyone else benefits (at least a little) from a weak Chinese economy.

China has contributed 40% to global growth rates over the past ten years, according to Dhaval Joshi, chief strategist at BCA Research. Any economic problems in Beijing will weigh on world production.

But for the moment, the consequences of China’s deflation seem manageable both for China itself and for the rest of the world.