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Deflation Coming to China? Brace Yourself, America

The Chinese economy can’t seem to catch a break these days. Two years ago, analysts—along with the Chinese government—were concerned about overheating and runaway inflation. For the past couple years, there’s been an equal but opposite worry that China has reached the beginning of the end of the long period of rapid growth.

Via Meadia is less concerned about a temporary Chinese slowdown, whether the landing is “hard” or “soft” than we are about the prospect for a phase change in Chinese growth — a secular slowdown in growth as the Japan-style export led strategy reaches natural limits. But the short term fate of China’s economy has a lot of influence over what happens in the rest of the world given our shaky circumstances right now. And China watcher Evan Osnos offers some sobering observations in the New Yorker:

Already, Nike says that its Chinese stockrooms are piling up with inventory. Similar complaints are coming in from McDonald’s, Caterpillar, and Procter & Gamble Co. Within China, the stakes of a slowdown are high as well: for half a century, political scientists have recognized that political unrest does not tend to erupt in places that are most deprived; it hits when a pattern of rising growth and expectations abruptly stops. And that is Beijing’s worst fear. […]

There is a slowdown in steel and copper production, the first layoffs in a decade by manufacturers of construction equipment, and electricity production, which usually grows faster than the economy, grew by just 0.7 per cent in April, suggesting to those inclined to see it that growth may have flatlined. There are physical signs, too: coal and iron ore and other commodities are piling up at Chinese ports, and the huge fleet of coastal ships that usually move them around have been forced to venture beyond the Chinese seaboard, sailing out to look for new business—the freight equivalent of deer wandering out of the woods in search of food. Because it materialized out of the shadows, shipping people have it named the “ghost” fleet.

On top of all this comes today’s news that China may actually be headed for a period of deflation. According to the New York Times, consumer prices dropped 0.6 percent last month, one of the largest such drops in years. Coming on the heels of months of anemic growth, this has many worried:

Producer prices, measured at the factory gate, were down 2.1 percent in June compared to a year earlier, and down 0.7 percent in June compared with May. Those prices had started to weaken late last summer, about six months before consumer prices began eroding. […]

A few economists are starting to ask whether China could face deflation, a sometimes intractable condition of falling prices that can become self-reinforcing, as Japan has found over the past two decades.

This deflation has not yet reached alarming proportions, but the alarm bells will be going off in Beijing if it continues much longer. Look for China to fight any signs of deflation with vigorous stimulus measures; short term, at least, that could be good for the rest of the world.

[Update: A previous version of this post mistakenly claimed that Chinese deflation stood at 6 percent rather than 0.6 percent. This mistake has been corrected.]

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  • Kansas Scott

    I suspect others have already pointed this out but the article in the New York Times noted that “Consumer prices dropped 0.6 percent….” That does not translate into the “six percent deflation” claimed in your last paragraph. It’s six tenths of one percent.

  • Kenny

    QE to infinite.

  • Jacksonian Libertarian

    The NYT article said that the prices fell from May to June by -0.6%, they also said that year over year prices had increased 2.2%. However a -0.6% extrapolated for a full year would be 12 X 0.6 = 7.2% deflation rate which would destroy the Chinese economy.

    I would rather have 10% inflation than 1% deflation, inflation is a pain but people are flexible and can adapt, deflation is destructive with businesses going bankrupt, skyrocketing unemployment, and massive foreclosures from the increasing value of debt and the difficulty in obtaining the more valuable currency to pay for it.

  • Kris

    A digression:

    Lo these many years ago, I came across the following principle from the Jewish laws of “charity”: people should be provided assistance commensurate to the lifestyle to which they have been accustomed. In other words, someone who’s been poor his whole life should be given enough money for rice and beans, while a pauperized millionaire should be given enough money for lobster dinners. (Well, maybe not lobster, what with this being Judaism and all.) I daresay most readers will join me in finding this not principle far from self-evident.

    I have now read the following (which I’ve long been aware of) in this post: “for half a century, political scientists have recognized that political unrest does not tend to erupt in places that are most deprived; it hits when a pattern of rising growth and expectations abruptly stops.”

    Lightbulb! (Finally.) This Jewish policy is not about “charity” at all, but about keeping the social peace, by assuaging precisely those people who might be most inclined and able to upset it.

    I guess the Ancients weren’t necessarily all that silly and ignorant, after all.

  • Kris

    Kenny@2: “QE to infinite.”

    Of course not! Only until confidence returns.

  • ACS

    This probably means a well-timed invasion of Taiwan when things get dangerous enough for the ruling class. Let’s see how our ‘Smartest President Evah’ handles it when our biggest creditor does that.

  • Rich K

    Well heck, if Cat,Nike and McDonalds are trusting of the chicoms then by gosh I see no reason to fear for our future.We should all just sit back and thank our lucky stars that those loving chinese plutocrats have our backs.I know our President loves them and those great ideas they use to manage their affairs, as opposed to our messy way which never gets anything done.Right Tom Freidman.

  • Luke Lea

    I’m not a libertarian but Hayek was right when he described the price system as an irreplaceable institution for sending economic signals. China does not have a price system. There is no way the standing committee of the Politburo is going to be able to keep this 18-wheeler on the road. It is veering wildly as we speak.

    For instance there is a story today about how Lenovo, the Chinese computer maker, is going to do all its design and manufacturing in house instead of outsourcing parts like all its competitors. Prediction: Lenovo will bomb big time. Cadres are not businessmen, not no how, not no way.

  • KjO

    I am curious how this will all be affected by the One Child Policy. Couple slowing economic opportunities with severely unbalanced gender populations and it seems to me that civil unrest will not be far behind.

  • Mike Mahoney

    Deflation is only desructive to those in debt. Its the opposite side of the coin of inflation. Inflation is destructive to those who hold cash and beneficial to those in debt. Crying that the shoe hurts worse on the other foot is a position limited to debtors. The cash economy can thrive in a deflationary environment. The credir economy can’t. We’ve abused credit so this is a corrective.

  • gringojay

    ?Wasn’t USA cabinet member LaHood just the other day envious of China for way they get things done? Maybe after US presidential elections B.H.Obama can spare a day from the golf links to tell mainland China how to whip deflation – or at least convince them hope is good enough .

  • ThomasD

    China has been using their manufacturing industry to bootstrap their agricultural industry into the first world. Currently their agricultural output is highly labor dependent. They have about one generation left to get the process done otherwise, as a result of their aging population, China loses the ability to feed itself.

    An significant economic slow down would greatly impede their ability to finish their agricultural project.

  • tl

    @ Mike Mahoney “Deflation is only desructive to those in debt.”

    Deflation is not destructive only to those in debt. Consumers delay consumption, investors delay investment, and economic activity contracts. Why would anyone buy a car today when it will be cheaper tomorrow? Who’s going to build a factory that will be worth less than it cost to build on the day it’s completed? Who’s going to invest in a factory when the value of (and demand for) the goods it produces diminishes each day?

  • teapartydoc

    I’d like to say something about the adage about political unrest occurring after a slowdown of growth and raised expectations. This is not always true, and the French Revolution is often cited as an example of this, so I will focus on that. The French economy was inflated by the borrowing that financed the Seven Years War, and after they lost that war many of the policies developed during that war remained, chiefly price controls on grains and breads. The corn laws were still in effect in England, so subsidized English wheat flooded the European markets making expansion of French agriculture unprofitable with the price controls, thus exacerbating shortages within France and making it even less likely for additional ground to be utilized for production. Seeing that agriculture was the chief source of income that would be available for taxation, these circumstances made it even less likely that the King would be able to pay his war debts, thus creating the concatenation of events leading to the calling of the Estates General, etc. What is the application to the Chinese situation? Well, all of central banking and interest rate manipulation by governments have their origins in the financing of wars and the handling of post-war debt. Whether a nation is able to make the necessary adjustments to handle the debts incurred depends on that nation’s ability to change gears and get it’s economy off of the war footing and back onto a footing more suited to normal circumstances (see US economic history after WWII–1947 Congress). If, on the other hand, the powers that gained advantage during the conflict want to maintain the new status quo bad things will happen. What has happened to all nations utilizing central banks over the past fifty years is that social issues have been allowed to become the moral equivalents of war, and economies have been on a war footing during times of peace, with no post-war adjustment, and those who have enjoyed the advantages of that kind of economy do not wish to see things change. Bad things are going to happen, and it won’t just be in China.

  • bob

    you comments are so funny- all people that have a stake in the outcome whether short of long. Fact is that the current Chinese expansion started with Nixon- like 40+ years ago and no one has been able to stop it- but like all runaway rapidly expanding capitalistic economies, greed itself eventually sets in supported by high level corruption- economic growth gets exhausted and the new rich become fearful of their security- strange that this fear builds to epic proportions overnight- even without smart phones, facebook and twitter. Hang on boys and girls- economic hell is just around the corner.

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