China's Economy is Failing.

Recently, one of the world's largest superpowers, that of course being China, reported a rather worrying economic statistic that shows just how much the Chinese economy is struggling after their extensive lockdowns. Last Wednesday, the world's second largest economy reported that they had now fallen into deflation. According to official statistics, consumer prices fell 0.3% year on year, declining for the first time since early 2021. The result has been described as a stark indicator that China is failing to revive consumption after their extended economic shutdown, and as a result, is failing to reignite its economy.

So, just how bad is China's post-COVID economy? Confidence in China is so thin that consumer prices declined in July for the first time in more than 2 years. The consumer price index—that's this chart behind me—slipped into negative territory in July. There's no question that China is in deflation. This is interesting because, as we know, over the past few years, most major economies have been dealing with the opposite: inflation. Inflation is quite simply the prices of things going up.

It's brought on by a disruption to the supply and demand equation, where either demand rises, supply falls, or both happen at the same time. In most countries around the world, the pandemic did in fact cause both of these factors. Supply of goods and services was choked due to lockdowns, but concurrently, demand increased as central banks around the world printed lots and lots of money, which was in one way or another gifted to citizens through various stimulus initiatives. In the United States, that took the form of stimulus checks.

So, you had the dynamic of rising demand and low supply, which sparked inflation. But then you have China. Now, while the UK is struggling to get inflation under control, China's economy is suffering from the opposite: deflation. China is currently refraining from doing a large-scale stimulus program, which is keeping businesses and consumers poor, and is keeping demand very low. If demand stays low, then all of a sudden, businesses have to lower prices or reduce production, which makes them less profitable, and then deflation begins.

But the problem is, as businesses start to struggle, they usually look to reduce workers' salaries or lay off staff. If this is occurring across the whole economy, then citizens on average now have even less to spend, which makes them cut back even more, and so the cycle continues: the deflationary spiral. Many economists consider deflation more damaging than inflation, and countries need to be very careful not to let deflation last for too long; otherwise, you can start to get a change in consumer psychology.

Not only do consumers end up with less cash to spend, but they also form the mindset of holding off buying things both to save money and also because chances are prices will be better in the years ahead. In Japan, from the late '90s to really the mid-2010s, more often than not, you'd see a deflationary environment, and that bargain hunting mentality became a societal norm. Consumers would hold off spending where they could, which perpetuated the economic weakness.

As strange as this sounds, when the Liberal Democratic Party won the 2012 election, they actually said they were going to deliberately fire up inflation and that people should buy now before prices start rising. So, while inflation is definitely one issue, many would argue deflation is a bigger problem. So, with that in mind, you'd expect the Chinese government to be acting decisively to get themselves out of this pickle. Right? Wrong. As I said before, the CCP is currently refraining from doing a large-scale stimulus program, and that's keeping businesses and consumers poor, which is keeping demand low.

But that's a problem. Eswar Prasad, a China finance expert at Cornell University, was quoted saying, "The Chinese economy is now at serious risk of sliding into a deflationary episode that could spark a self-reinforcing downward spiral in growth and private sector confidence. The government needs to act quickly and decisively to put a floor on growth and limit deflation before matters get out of hand."

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Now, let's get back to the video. China is currently drifting into deflation, but the CCP is refraining from doing large-scale stimulus. So the question is, well, why aren't they helping? Well, as Bloomberg notes, it's feared that if the CCP did give out a lot of money to businesses and consumers right now, that money will simply end up in US dollar savings accounts, as short-term US Treasury bonds are paying a lot higher than China's one-year bonds.

Ultimately, if stimulus money ends up in these US dollar savings accounts, then it's not being spent to boost China's economic activity. They're worried the money will simply be saved and not spent. That's not a situation the CCP wants. So at least for now, they stay silent on large-scale handouts. But how long can that go on for? As the Financial Times notes, the move into deflation is set to fuel calls for more government stimulus at a time when policymakers are also grappling with the property sector slowdown and weakness in trade, all of which have dragged on economic momentum.

There's only so much pain the CCP will take until they step in and boost the economy, and we're probably getting pretty close. Manufacturing activity in China slowed down for a fourth consecutive month in July, with the purchasing managers' index coming in at 49.3. Any value under 50 indicates month-on-month contraction, and as you can see, this metric has really been struggling since late 2021. China recently reported a 14.5% drop in exports and a 12.4% decline in imports. That's not great.

They're also facing a major youth unemployment crisis, with one in five young people without a place to work. So there's no doubt China is facing a very sluggish economy after their grand reopening about 7 months ago. But it is worth noting that while the CCP may not have announced exactly what they're going to do about it, they are very aware of what's happening. About 4 weeks ago, the 24 member Politburo noted themselves that China's economic recovery was making tortuous progress, and it was necessary to actively expand domestic demand and expand consumption by increasing residents' income.

They noted in particular it is necessary to boost the consumption of automobiles, electronics, and home furnishings, and promote the consumption of services such as sports, leisure, and cultural tourism. So they know what they need to do; they're just refraining from doing direct cash handouts and instead trying to work out the best ways to incentivize spending and economic growth in other ways.

They've already taken some action too. In June, they cut interest rates for the first time in almost a year to help stimulate borrowing. Last month, they extended credit support for developers to help their property sector. They even took the time to reassure businesses that their regulatory crackdown is now over. They've also indicated a need to stabilize foreign trade and foreign investment and to increase international flights once again.

So while the Western media loves to hook into the Chinese government, the one thing they are not is stupid. While yes, China is undoubtedly facing a tough economic period and a very sluggish recovery from their COVID lockdowns, the government will ultimately do what it needs to do. And honestly, I hope they do.

I think one thing that gets forgotten about in the general China bashing that happens in the media is that, whether you like it or not, they hold a very important place in the global economy. I've said this stat many times in the past: China is responsible for about a third of the manufacturing output of the Earth. As I noted earlier, China just reported a 14.5% drop in exports and a 12.4% drop in imports. Well, what are they exporting? Stuff that we need. What are they importing? Stuff that we're trying to sell here in Australia.

China is our number one trade partner. Who buys our iron ore? China. Who buys our natural gas? China. Who buys our grains and our meat? China. Now, Australia is a bit of an outlier when it comes to trade relations with China, but there's no doubt they form an important part of the global economy, and what happens in China probably affects you more than you think.

But with that said, let me know what your thoughts are on China. Do you think they'll be able to reverse their deflation? Do you think they'll implement some big bazooka-style stimulus program? Definitely let me know, and let's have a conversation down in the comments. I particularly want to hear from you if maybe you work in this area or if you have any sort of specific insights; that would be really cool to hear.

But with that said, guys, thank you all very much for watching. Please leave a like on the video if you did enjoy it, and I'll see you all in the next video. Is deflation deflation?