summarise: -- July’s data left no doubt: China is now
clearly dealing with a deflation threat. Consumer and producer
prices fell together for the first time since 2020, adding to
concerns about the health of the world’s second-largest economy.
News that China’s prices are falling may be somewhat jarring,
given the inflationary pressures in many other parts of the
world. But the unique factors contributing to China’s problems
are deep and ingrained. Solving them may not be an easy fix.

1. Why is China in deflation when other countries have
inflation? 

Inflation rocketed higher in the US and other major
economies as they reopened after the Covid-19 pandemic, with
pent-up demand fed at times by government handouts. At the start
of this year some economists predicted the same would happen in
China, which ended its Covid curbs later. But that hasn’t been
the case. Consumer spending growth remains subdued, while a
prolonged property slump has dented confidence, holding people
back from buying big-ticket items and impacting prices for
furniture and home appliances. Energy prices have been falling,
too, given weakness in global commodity costs and Beijing’s
long-standing control over the power sector. A price war among
carmakers has added to deflationary pressures, while companies
are also cutting prices to reduce the excess stock they built up
over the pandemic. Prices aren’t falling across the board,
however. Spending on services, such as travel and restaurants,
has surged since pandemic restrictions ended, with prices
continuing to rise in those sectors.

2. If everything is cheaper, isn’t that good for consumers? 

Not really. Cheaper prices look good for consumers at first
glance, but that doesn’t necessarily mean those shoppers will
start spending money. When prices drop across a wide range of
goods for an extended time, people start thinking it’s best to
put off buying expensive items like appliances, thinking the
price will continue to fall. That curbs economic activity even
further, in turn forcing businesses to reduce their prices. For
the consumers, that usually translates into earning less or
losing jobs, which then results in less spending in a dangerous
spiral downward.

3. What about the impact on businesses? 

Lower prices generally lead to weaker revenue and profits,
which then prompt companies to curb investment and hiring.
Deflation also raises the level of “real,” or inflation-
adjusted, interest rates in the economy. A rise in servicing
costs for loans for businesses reduces their ability to invest,
which in turn crimps demand, inducing more deflation. Some
economists believe such “debt deflation” can trigger recessions
or depressions as people default on their loans and banks are
undermined. Look at Japan, where falling prices took hold in the
1990s and contributed to a prolonged period of stagnation that’s
still haunting the world’s third-largest economy. The country is
still dealing with the question of how to spur economic growth
in a sustainable way. The Bank of Japan’s deployment of negative
interest rates has done little to move the needle, prompting new
tweaks to monetary policy this year.

4. How long is this deflation going to last?

Plummeting food and energy costs contributed heavily to the
downward pressure on July’s figures, and some economists see
those prices becoming less of a drag through the rest of the
year. Factory-gate prices have been in deflation for longer,
since October 2022. Even then, July’s reading marked a slight
improvement from the previous month, suggesting some
stabilization in producer prices. In general, China’s inflation
has been on the low side for a decade, with economists citing a
high household saving rates and high investment leading to rapid
increases in industrial capacity as reasons.

5. What is Beijing likely to do about this?

The People’s Bank of China could cut interest rates further
or reduce the amount of cash banks have to hold in reserve. The
problem is the central bank faces several constraints, such as a
weaker yuan and already elevated debt levels, especially at the
local government level. Fiscal support — stimulus — has also
been moderate given the financial strains, meaning authorities
are less inclined to rely on big spending measures as in the
past and instead turn to targeted strategies. Beijing has also
encouraged regional authorities to find ways to get people to
spend money, too.

6. What about foreign investors? 

The clearest impact may be to corporate earnings, given the
pressure on companies to cut prices during times of deflation.
Where there’s a bit more upside is in bonds, which better
protect investors during times of trouble. Concerns about growth
and curbed investment usually prompt governments to deploy
looser monetary policy, making a country’s bonds more
attractive, too. However, Ken Cheung, chief Asia FX strategist
at Mizuho Bank Ltd., said the yields on China’s sovereign debt
are simply “too low compared to major markets” to be appealing
to foreign traders.

7. What does this mean for the global economy?

There may be some benefits for developed countries, at
least in the short term. As Chinese manufacturers cut prices to
shed excess supply, that may ripple through to places like the
US and Europe, providing some help for central banks there as
they work to tame elevated inflation. There are some
limitations: Both regions have become more protectionist in
recent years and tried to limit their dependence on China. And
Chinese-made goods make up a relatively small share of consumer
spending in developed countries. For example, the US CPI
(consumer price index) basket is dominated by shelter, food,
energy and medical care, which have relatively little to do with
imports from China. Emerging markets might welcome lower
machinery prices — though with some caveats, as analysts have
noted those countries may be wary about welcoming too much
Chinese competition undercutting domestic industries. 

8. Has this happened before? 

Yes. Each time, in 2009, 2015 and 2020, Beijing responded
with forceful monetary easing and large fiscal stimulus. While
Beijing has vowed to accelerate some infrastructure projects and
increase support for the slumping housing market this time, many
economists aren’t expecting a large-scale building boom as in
the past, as President Xi Jinping has been focused on shifting
its economy toward new growth drivers, such as advanced
technologies. That would make Beijing’s response more similar to
its response to a 1998 period of deflation, which is now
remembered as structural. Beijing recapitalized underperforming
banks and downsized its state-sector ahead of joining the World
Trade Organization.