Navigating Inflation Woes in the West, China Jetzt preisgefährdet durch Deflation

**China’s Deflation Problem: A Disaster in the Making**

**Why Prices Might Keep Falling**

China’s economy was expected to experience a surge of economic activity after the easing of strict COVID-19 lockdown measures. However, the reopening has failed to boost economic growth, resulting in consumer prices in the country stalling. China’s consumer price index (CPI) was flat in June, with core inflation falling 0.1% from a year ago. China’s producer price index (PPI) also saw a sharp decline, sinking 5.4% year over year last month. These data indicators reflect weak demand for core goods and a decline in raw material prices.

To counter the anemic growth and falling producer prices, the Chinese government and People’s Bank of China (PBoC) have implemented measures to boost spending and investment. The PBoC has cut its key medium-term interest rate, and the Chinese State Council has promised to roll out more forceful measures to stimulate economic growth. Analysts from Nomura expect more fiscal and monetary stimulus to be implemented throughout the year.

**An Alarm Bell for China**

If China fails to boost economic growth and slides into a deflationary environment, it could be a nightmare scenario for the nation. A deflationary environment combined with an elevated debt environment, as seen in Japan’s “lost decade” in the 1990s, would be disastrous for China’s potential growth. Deflation makes debt more expensive and delays consumption and investment as consumers expect prices to fall further. Without a social safety net, Chinese consumers are forced to save more instead of spending, hindering economic growth.

Richard Koo, chief economist at Nomura Research Institute, warns that China is facing a “balance sheet recession,” similar to Japan’s experience in the 1990s. This shift from investing and spending to debt minimization exacerbates the impact of deflation. Additionally, China’s lack of a strong social safety net further restricts consumer spending and investment.

**Good News for the Federal Reserve**

While China’s deflation issue poses risks for its domestic economy, it may be welcomed by the U.S. Federal Reserve, which is striving to combat inflation. The weak post-pandemic recovery in China could lead to deflationary pressures on the global economy. This could help the U.S. producer price index (PPI) inflation rate to surprise to the downside, which aligns with the historical correlation between China’s and the U.S.’s PPI given their trade relationship.

Although no central bank desires deflation, the Federal Reserve may view global disinflationary currents favorably in its battle against rising U.S. consumer prices. If import prices decrease, it indicates less pass-through to consumers and results in lower consumer price inflation. This aligns with the Fed’s goals.

**Long-Term Stakes for the Global Economy**

China’s rise as a global superpower and economic rival to the U.S. since the 1990s has reshaped the world. However, persistent deflation could challenge China’s status in the long term, similar to the America-Japan rivalry of the 1980s. For China’s Generation Z, who already face record-high unemployment rates of over 20%, the consequences of deflation could be disastrous.

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