China’s economy is being affected by one of Japan’s old problems: deflation, which includes falling commodity and asset prices, declining corporate profits, and slower economic growth.
The first sign of Chinese deflation appeared in the first half of 2022, when the annual change in the Producer Price Index, a measure of wholesale inflation, began to slow down. It eventually turned negative until the most recent February numbers were released last week.
The second sign of deflation showed up in the latter half of 2022, when the change in the Consumer Price Index (CPI), a measure of retail inflation, began to slow down, too. Then it continued to swing between negative and positive territory, with the February number reported last week decisively negative amid weak consumer spending following the Spring Festival at the end of January.
The third sign of deflation is falling asset prices. New home prices in the country’s 70 major cities declined at an annual rate of 5.0 percent in January, following a 5.3 percent drop in December 2024. In addition, the iShares China Large-Cap ETF (FXI) has been down close to 10 percent over the last five years, during which the U.S. benchmark S&P 500 Index gained 97 percent over the period.
Juscelino Colares, a professor at the School of Law at Case Western Reserve University, believes China’s deflation results from the Chinese Communist Party’s unintended engineering.
“China’s consumer and producer prices fell in February due to excess capacity in its export sector and well-grounded expectations of lower trade volumes,” he told The Epoch Times via email. “The late 2024 heydays of front-loading exports in anticipation of Trump’s second term are over, and the economic outlook has decreased.”
Colares sees four additional headwinds to China’s economic growth: the continuing and increased tariffs from President Donald Trump’s first and second terms; further decoupling from Western economies; less access to Western technology (including last-generation chips); and a decline in the flow of foreign direct investment.
“One may argue these factors have had a lagged effect and that deflation is the result of one-off processes that may subside once adjustments occur,” Colares said. “Yet, deep-seated secular problems would suggest that rather than reversal to the mean, one is likely to see China go the way of Japan, a dynamic powerhouse plagued by deflation and secular stagnation since the late 1990s.”
Colares sees a strong parallel between China’s housing and commercial real estate bubble and Japan’s in the late 1990s, another example of excess capacity.
“When individuals and companies expect real estate prices to fall in the future, they err on not building or not buying in the short run,” he said. “The pursuit of better bargains in the future feeds deflationary pressures.”
Another driver of China’s deflationary pressures is the country’s inability to transition from a nation of producers and savers to a country of consumers, following the path of the world’s largest economy—the United States—and other emerging market economies.
That compares with consumer spending of 67.8 percent of GDP in the United States, 63 percent in Brazil, 60.4 percent in India, and 52.7 percent in the European Union.
“The Chinese people’s propensity to save (similar to the Japanese) further aggravates this problem,” Colares added. “Add in an aging and declining population (who would think this has not been a problem in Japan?), and the outlook for further deflationary pressures and secular stagnation becomes more likely. ”
Colares urges caution for Chinese policymakers: “The combination of adverse political winds from Washington and these secular trends should cause some skepticism that Chinese premier Li Qiang’s pledge to increase government borrowing and thus ensure a revised growth target to 5 percent will materialize,” he said. “China is the new Japan.”
