Chris Gills
Financial Times
August 16, 2023

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

But will falling prices have an impact beyond China’s borders, in places where the bigger risk is still that an extended period of high inflation will endure?

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

Chinese deflation is likely to prove temporary

Deflation is primarily a concern when it is pervasive and caused by companies desperate to sell to consumers who are unwilling or unable to buy because they have fallen on hard times.

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

The economic recovery following the reopening has disappointed — the property sector remains a serious concern — but output is still growing and an expansion of close to 5 per cent this year is still on the cards.

“China’s consumption recovery remains soft and uneven, but this 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 falling prices.

While Chinese consumer prices fell 0.3 per cent in the year to July, a small fall in costs also occurred in 2021. Now as then, the deflation appears temporary — more the result of base effects than any deep problems.

In July alone, prices rose by 0.2 per cent and they have increased 0.5 per cent in the first seven months of 2023. The measured deflation arose because prices — particularly of pork, which has fallen in price by 26 per cent over the past 12 months — did not rise at the pace seen during 2022, when China endured several major lockdowns.

Neil Shearing, chief economist of Capital Economics, said the rise in core inflation — which excludes food and energy, and is seen as a better measure of underlying price pressures — from 0.4 per cent in June to 0.8 per cent in July demonstrated the lack of entrenched deflation in China. “To the extent that chronic demand weakness shows up in the inflation data, it will do so in the core numbers,” he said.

Inflation is seldom as contagious as it seems

The world — bar China — has appeared to suffer an inflation boom during the past couple of years. While the pace of price rises has been high in most countries, the reasons why differ markedly.

Price rises triggered by snarl-ups in global supply chains may have been universal. But they were amplified in the US by extremely strong consumer demand growth. The surge in demand followed a huge fiscal expansion in 2020 and 2021, when the Trump and Biden administrations sent large cheques to households to combat the Covid-19 crisis.

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

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

While the price of Chinese imports was likely to fall as a result of the country’s economic woes, Donovan noted that “an awful lot happens” to exports before they reach their final destination. “Generally most of the price of something made in China and sold in the US will be paid to US workers — in transport or advertising costs, and so on,” he said.

Chinese deflation can help in Europe

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

Chinese factory goods prices were 4.4 per cent lower in July than a year earlier. To a minor extent, this has an effect abroad.

European countries will benefit from a weaker Chinese economy that places less competition on supplies of natural gas as it adjusts to weaning itself off from Russian supplies.

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