China heads into deflation as lending boom impact ends

Economic growth


China PPI May13.pngSometimes a picture really is worth 1000 words. This is certainly true with the above chart, showing China’s producer price index since 2008:

• It highlights prices up 10% at the peak of the export boom, before the H2 2008 crash
• Then it shows the short-lived recovery after China’s massive lending boom
• Finally, we see how over-capacity is now leading to consistent deflation
• Even the pre-Party Congress lending boom of May-October 2012 has now lost its effect

This is the problem with economies built on liquidity and external stimulus. When these supports finally end, domestic consumption is unable to fill the gap. As the Wall Street Journal notes:

“Producer prices–a measure of prices of goods before they reach consumers–dropped 2.4% in April, the sharpest decline since October, paced by particularly steep falls in the metals and chemicals sectors. That could add to concerns about slowing Chinese economic growth, say economists, because falling producer prices makes it tougher for producers of industrial goods and commodities to make profits, pay off their debts and pay their suppliers on time.”

Japan has faced the same problem for 20 years. It has tried to maintain economic growth via exports and its own lending/stimulus programmes. But they have failed, just as China’s have failed. And just as those of the West’s are also failing.

A much better route is to accept that the world has changed, and instead develop the economy in a new direction. This policy avoids the wasted investment in capacity that will never be used. And it avoids piling a burden of debt on younger generations, which they will never be able to repay.

The same point is made in a different way by Prof Stéphane Garelli, the head of the World Competitiveness Centre at Swiss business school IMD as follows:

“Today very few countries are still closed to world competitiveness. There are some obvious candidates such as North Korea, Myanmar, Cuba and Iran. But even if they do open up fully, none of them will reshape global competitiveness like the post-1989 generation did. As the global market increasingly shifts from being a “first buy” economy to a “replacement” economy, competitiveness will develop more slowly.

Growth will depend more on technological innovation and better skills than on accessing cheap factors of production in uncharted lands. This will imply more time to see results, and a new mindset. As the French writer Paul Valery put it, “the problem with our times is that the future is not what it used to be…” The last 25 years of competitiveness were exceptional, even epic. But now we should turn the page, and work on a ‘new normal’.”


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