China’s Deflation Reflects Its Extra Crises

China’s Deflation Reflects Its Extra Crises
An investor looks at a screen showing stock market movements at a securities company in Hangzhou, in eastern China's Zhejiang Province on Feb. 8, 2024. (STR/AFP via Getty Images)
Law Ka-chung

Whenever the U.S. and China are compared from an economic perspective, people tend to highlight the difference in prices: the former has high inflation while the latter has deflation.

In principle, quantity is a more important variable to compare. Still, China’s GDP (YoY) growth, as reported, is too high to believe, at double that of the U.S., it differs drastically from casual observation.

China’s deflation looks more realistic than the country’s other official data, yet the direction of price change might not be as opposite to the rest of the world (and the U.S.) as one might originally think.

Let us compare the inflation in the two countries in the recent episode, which was marked by the post-outburst of COVID-19, where lockdown measures and logistic blockages happened everywhere.

Over these few years, we can see from the accompanying chart that the two series of inflation commove quite well, exhibiting very close peaks just differing by three months—a difference which is not significant in an economic sense.

This suggests both the U.S. and China and probably most other countries experienced the same set of global push factors.

However, the occasional reductions in China’s inflation are obvious from around mid-2021. This was precisely the time when China’s leading developers had their debt crises intensifying. Apart from the occasional ones, the overall pullback impacts were also there, as evidenced by the disproportionate movement of the two series.

U.S. and China CPI Inflation. (Courtesy of Law Ka-chung)
U.S. and China CPI Inflation. (Courtesy of Law Ka-chung)

When U.S. inflation surged by 1 percent, China’s rose by only 0.4 percent. In theory, a developing country like China should have higher inflation (both in level and volatility) than a developed country like the U.S. This opposite indicates abnormality.

From early 2023 onwards, the divergence in level became obvious, and from mid-2023, the divergence in direction was observed.

Notice the monetary policies differed drastically where the U.S. hiked the rate by over 5 percent cumulatively. In contrast, China did not do any, and the U.S. also shrank the Federal Reserve’s balance sheet while China was increasing money and lending speedily.

Had there not been such counteracting forces, the contrast would have been much sharper than observed. There are no symptoms of reversing as the latest data show the U.S. tends to reinflate again. Prices are usually the consequence of aggregate demand and supply. Given there have been no major supply shocks recently, the difference in inflation is most likely caused by the difference in aggregate demand.

Such a persistent divergence implies a strong pullback force in China or a strong push force in the U.S. (or both). But the former is more likely, given the latter is tightening. Such pullback force is inferentially likely due to the collapse of the real estate industry and debt sectors, where the impact has likely been transmitted to all other sectors, driving inflation to negative.

This writing derives something that looks common sense, but the reason for doing so is China’s official mouthpiece denies the above hypothesis and downplays deflation.

Some banks or fund houses are making calls to buy China, but the above theoretical derivation suggests the risk of doing so is still very high.

KC Law, Ka Chung
Law Ka-chung is a commentator on global macroeconomics and markets. He has been writing numerous newspaper and magazine columns and talking about markets on various TV, radio, and online channels in Hong Kong since 2005. He covers all types of economics and finance topics in the United States, Europe, and Asia, ranging from macroeconomic theories to market outlook for equities, currencies, rates, yields, and commodities. He has been the chief economist and strategist at a Hong Kong branch of the fifth-largest Chinese bank for more than 12 years. He has a Ph.D. in Economics, MSc in Mathematics, and MSc in Astrophysics.
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