China’s economy is struggling. The recovery after the lifting of Covid-19 restrictions is faltering. Its trade with the rest of the world is shrinking. A decade-long boom in house prices has come to an end.
The most obvious manifestation of the troubles besetting the world’s second biggest economy is that China is now officially in deflation. In the US, the UK and the eurozone, prices are rising – albeit not quite as fast as they were a few months ago – but in China they are actually falling.
News of the 0.3% year-on-year fall in prices inevitably prompted speculation that China was about to be permanently gripped by deflation, as was the case for neighbouring Japan after its asset-price bubble burst at the end of the 1980s.
Such fears are premature, at least for now. There were one-off factors involving the price of food that explained last month’s fall. Core inflation – which excludes volatile items such as energy and food – not only remained positive, but actually rose from 0.4% to 0.8%.
That said, China’s communist leaders are clearly worried about the state of the economy, and they are right to be concerned. Attempts to rebalance the economy away from investment and exports towards consumer spending are still in their early stages. Factories are seeing demand fall because of the slowdown in global demand.
It is not just consumer prices that are falling. The prices of goods leaving China’s factories have fallen by more than 4% over the past year, which will eventually feed through into cheaper imports for the rest of the world. Any downward pressure on inflation will be welcomed by developed country central banks.
There’s more bad news. In an echo of the events that prompted the global financial crisis of 2008, house prices are falling and property prices are feeling the pinch. Country Garden, one of China’s leading private sector developers, missed two bond payments earlier this week.
Perhaps most worryingly for the authorities in Beijing, youth unemployment is already running at 20% and could rise further as newly qualified graduates look for work in an economy where growth is slowing. Ever since the Tiananmen Square massacre of 1989, the Communist party has been anxious to avoid having large numbers of angry, unemployed young people protesting on the streets.
In the longer term, the president, Xi Jinping, has no real alternative but to stick to his rebalancing strategy. The reason the economy grew strongly in the years leading up to the pandemic was that Beijing kept the money taps full on. The state invested heavily in new manufacturing capacity, and property companies expanded on the back of plentiful supplies of cheap finance. As a result, China now has a vast amount of underutilised factories and homes that nobody wants to buy.
Does this mean Beijing will adopt a hands-off approach to the economy? Almost certainly not. Deflation – even if temporary – will prompt the authorities to stimulate demand through lower interest rates and higher government spending.
In all likelihood, though, the interventions will be smaller and more targeted than in the past. The China expert George Magnus says China’s long-term sustainable growth rate is now 2%-3%, a far cry from the 10% seen in the immediate aftermath of the global financial crisis. The road to that lower, better-balanced growth is bumpy and strewn with obstacles.
