Getty Images; Alyssa Powell/BI
This is a machine translation of an article from our US colleagues at Business Insider. It was automatically translated and checked by an editor.
For decades, China’s growth was considered guaranteed. Everything got bigger, from the economic power to the cultural influence to the geopolitical ambition of the leadership. The basis for this rise was the booming economy, which enabled Beijing to exert its power in many areas. But now China’s economy is weakening, and the future that the communist government has envisioned is beginning to falter.
The clearest sign of this decline is China’s deflation problem. While Europeans and Americans were worried about inflation, i.e. prices rising too quickly, politicians in Beijing are worried because prices are falling. China’s consumer price index has fallen over the past three months. This is the longest period of deflation since 2009.
Deflation is a sign that China’s economic model has run out of steam and requires a painful restructuring. The falling prices are also a sign of a deeper unease that is spreading among the Chinese people.
“The deflation in China is a deflation of hope, a deflation of optimism. It’s a psychological crisis,” Minxin Pei, a political science professor at Claremont McKenna College, told me.
The consequences are not limited to China. For decades, China’s growth had also led to a global flood of money. There is now a risk of a backlash effect on the global markets. Foreign investors who contributed to China’s rise are withdrawing. Governments around the world are questioning China’s geopolitical claims. What the government in Beijing does or fails to do now to combat this malaise may determine the course of humanity for decades to come.
Deflation in China: flirting with catastrophe
It may seem counterintuitive: but deflation is in many ways scarier than inflation. Inflation occurs when there is too much demand for too few products. People want to buy something, but there isn’t enough of it for everyone. So the prices go up. In contrast, deflation occurs when there are too many goods and services but not enough demand. Companies are then forced to reduce prices. Every economy experiences recessions or downturns, but sustained deflation only results when crises take root and remain.
China’s deflation began in the summer. Consumer prices fell by 0.3 percent in July compared to the same month last year. This had not happened since the low point of the corona pandemic. Prices appeared to stabilize in August. But then pork prices, which are important in China, began to fall drastically. This pushed the overall price index down in October, November and December. Policymakers hoped that the effect would be dissipated by volatile pork prices. But new data shows that core inflation excluding food and energy prices was only just positive at 0.6 percent in December.
Charlene Chu, director and senior analyst at Autonomous Research, said the key question for Beijing is whether price declines will continue in 2024 or demand will pick up again. But she has little hope for that. “I lean toward deflationary pressures continuing to increase, but the data will continue to fluctuate throughout the year,” Chu wrote to me.
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China’s main problem is debt, particularly in the real estate sector, which accounts for 25 to 35 percent of economic output. Too many apartments have been built for years, while the population was already growing more slowly and recently even shrinking. Prices collapsed. The real estate problem has left a deep mark on the fortunes of Chinese households. Many have invested a large portion of their savings in real estate. This affects the entire economy.
“The Chinese have invested 70 percent of their wealth in real estate. You can imagine how this affects confidence,” Wei Yao, chief economist at Société Générale, told me. “That’s why this deflation could be long-lasting.” Many Chinese have sharply reduced their consumer spending.
“I think it’s unrealistic to think that deflationary pressures will disappear when housing prices are still under so much pressure and consumers are in austerity mode,” Chu said.
How China would have to fight deflation
Back in 2002, Ben Bernanke, who later became chairman of the US Federal Reserve, gave a well-received speech about how to combat deflation. As an economic historian, he worked extensively on the Great Depression of the late 1920s – the mother of all deflationary crises. Based on his research, he came to some conclusions. Here are a few that are relevant to the current situation in China:
Deflationary events are rare, but even moderate deflation, “a fall in consumer prices of about 1 percent per year,” can stifle an economy’s growth for years. In a deflationary economy, it becomes increasingly difficult to repay debt because money becomes scarcer – a situation called “debt deflation.” “It is better to prevent deflation than to cure it.”
Chinas Staatschef Xi Jinping Xie Huanchi/Xinhua via Getty Images
Japan is a recent example of a deflation trap. After decades of rapid growth, the country’s economic growth collapsed in the 1990s due to high debt and an aging population. Together, these forces pushed the country into deflation. Does this sound familiar?
What we have learned from Japan’s years of stagnation is that a way out of deflation can be painful debt restructuring. Société Générale’s Yao told me that Beijing could still prevent the onset of deflation with a rapid anti-debt campaign. The problem is that there is no evidence that the Chinese Communist Party is willing to do this.
What is the Chinese Communist Party planning?
Bernanke would probably advise China to take dramatic action immediately. Send checks, drop money from helicopters, and at least get people to spend money again. Deflation can only be combated by stimulating demand. But the CCP’s unwillingness to help Chinese households, even amid the deep COVID-19 crisis, makes this unlikely.
“China has not provided any fiscal support during the pandemic,” Yao recalled, “all other major economies have provided some form of stimulus.”
After all, Beijing took some measures last year to improve financial conditions for banks and state-owned companies. It also lowered interest rates slightly. But it will take time for supply-side measures to become mainstream in the lives of ordinary people and also to stimulate demand – if they do so at all.
“A real acceleration next year requires either a bigger global surprise or more active government policy,” economists at China Beige Book, an analyst of the Chinese economy, wrote in a note to clients.
It’s not that the CCP doesn’t know about the problems of the economy. China’s head of state Xi Jinping even mentioned the fact that the people are suffering financially in his New Year’s address – a first for him. The party officials are stoic. They do announce that China’s GDP growth is meeting expectations. But their cautious tone and their courting of the international economy show concern. The question remains: If Beijing knows how bad the situation is, why isn’t the government doing more?
Analysts are divided on why there is no support for households. In an August research report, Logan Wright, an analyst at Rhodium Group, argued that China’s ability to provide financial stimulus is being greatly overestimated. “Beijing’s leverage is much more compromised than is generally assumed,” Wright said in an interview: “The problem is that China hardly raises any taxes outside of its investment-led growth model.” Beijing is up to its neck in debt.
But there is also another option. It’s not that Beijing can’t take stimulus measures, it’s that it just doesn’t want to. Xi does not believe in direct payments to people. And with China under his control, that’s all that matters now.
“I came to the conclusion that it was some kind of ideology,” Yao told me. “Xi Jinping wants to develop his own economic system. He tries to avoid mistakes like the West, namely wasting money on something that will not benefit him in the long term. Seen this way, sending checks to households does not produce long-term returns.”
Maybe it’s a little of both. There have been times in the history of the Chinese Communist Party when various factions – reformers and opponents of reform – have had space to debate and change the government’s policy course. In Xi’s China, that space has disappeared, shrunk to what fits in the palm of his hand.
It’s not just about China’s economy
Xi’s regime has meant that any space outside the CCP’s influence has become smaller. This includes the arts and intellectual life, but also the private sector. Before Xi, China was a country that learned to deal with a variety of voices – as long as they didn’t attack the country. China under Xi is a country where people also speak in code online to express even the slightest dissatisfaction.
China’s internal problems do not necessarily mean that the country no longer poses a challenge to the United States or Europe. It just means Beijing is prioritizing where it invests in this competition. Xi will not back down from investing in the military, as unification with Taiwan remains his top priority. The central government will continue to invest in technology and in supporting industries where it believes it can get a head start. Think electric cars, batteries and solar cells.
“We don’t believe the U.S. faces a growth challenge from China at this point,” said Rhodium Group’s Wright. “The concern of the US and Europe is the impact of overcapacity.” In other words, China will pick its battles more selectively and defend its economic advantages more aggressively. The world is also threatening to break down again into smaller markets and sub-centers. And the insults that China has suffered as a growing superpower will only hurt more in its weakened state. Xi will never stop trying to save face. This is the nature of his one-man rule.
Linette Lopez is a senior correspondent at Business Insider.
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