The Chinese economy, a global powerhouse for the past few decades, is facing a daunting challenge. The nation’s consumer price index is clearly indicating deflation has arrived with a -0.5% growth rate over the previous year. That is the largest dip since the financial crises induced by the tech bubble, the global financial meltdown, and the Covid-19 pandemic. This marks the fastest pace of price declines in three years.
On the flip side, core inflation in China has managed to remain in positive territory. Food and energy prices are dropping at a more rapid pace compared to the core basket of goods. This divergent trend is an important factor in the understanding of the nation’s economic malaise. The question is if goods will drop in price because consumer demand is waning. I suspect they will in a more pronounced way.
Why? Consumer demand remains frail. This weakness in demand has been a persistent issue since the post-pandemic reopening for China. Despite the lifting of restrictions and the resumption of economic activities, consumers have been reticent to return to their pre-pandemic spending levels.
The People’s Bank of China (PBoC) faces a conundrum. It is likely unable to afford a sizeable stimulus package, which could potentially reinvigorate the economy. Without such a stimulus, China might be teetering on the brink of a prolonged economic slowdown, which could have far-reaching effects on its population and the global economy. I fail to see how a prolonged recession in the world’s second-largest economy wouldn’t cause a slowdown in the US.
The Chinese government, for its part, has been verbalizing its intent to stimulate demand, investment, and growth. However, the catalyst for this proposed revitalization of the economy remains unclear.
The government’s past measures to boost the economy, such as reducing corporate taxes and increasing infrastructure investment, have had little impact on persistently weak demand. And with a real estate slump, high youth unemployment, and rising tensions with the West, it’s hard to envision a particularly optimistic secular rebound.
The Bottom Line: Why China’s Deflation Matters
China’s role as a leading commodity consumer means its economic health has implications for global prices. A decline in domestic sales may result in an increase in cheap exports, affecting global markets. In turn, this could result in further disinflationary pressure in the U.S. In other words, the weaker China is, the weaker commodities likely will be, further putting the U.S. at risk of outright deflation as well.
The economic downturn in China, marked by a worrying slip into deflation, is a complex issue. And it’s one U.S. investors I believe must pay attention to as it could have wide-reaching implications on interest rates and broader volatility ahead.
On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
