FOR more than a year, the “slowing Chinese economy” has been one of those boilerplate explanations for tepid global economic growth, although the unequivocal evidence of a “slowdown” has not quite appeared. Now it seems that not only is the slowdown not happening, China may, in fact, provide unexpected stimulus to the rest of the world.
Last Friday, the People’s Bank of China announced that the producer price index rose 3.3 percent year-on-year in November, the biggest jump in five years and much higher than the consensus forecast of 2.3 percent. It was the third straight month of growth in the PPI; September reversed a nearly four-year decline in prices, while October’s factory gate prices rose by 1.2 percent.
Along with the big jump in the PPI in November, China’s consumer price index, a measure of retail price inflation, rose by 2.3 percent year-on-year, slightly faster than analysts’ 2.2 percent consensus forecast.
From a consumer point of view, inflation is generally considered a bad thing, but from an economic point of view, November’s PPI and its implications are the best news to come from the world’s second-largest economy in a long time.
For the Chinese domestic economy, steadily declining producer prices have a ripple effect that causes the entire economy to retract. Lower prices mean that factories can produce the same amount at lower cost, but that also means their margins are lower. The margins are likewise lower for every part of the supply chain, and to make matters worse, lower prices paradoxically reduce consumer spending.
This happens for two reasons. The direct reason is that as companies’ sales and margins shrink, wage growth stops or even retreats; this usually happens through companies slowing or stopping hiring and raising wages, but if it goes on too long, can result in actual job or wage cuts. Consumer spending power is thus reduced, if not in tangible terms, then through caution because of the uncertain labor environment.
The less obvious reason, but one that has a big impact, is that a deflationary cycle causes consumers to delay spending, particularly on big-ticket discretionary purchases. If prices are falling, that car or washing machine may have a lower price next month, so consumers tend to wait. That also applies to businesses; a real estate developer, for example, may hold off starting construction on a project, eyeing a potential better deal for construction materials in the next month or next quarter. The lack of spending simply aggravates the situation, because companies’ revenues decline.
By contrast, when prices rise, economic activity rebounds. Of course, prices can rise too high and kill spending through making goods unaffordable, but within a fairly broad range—2 to 4 percent is thought to be ideal, although that is debatable—inflation stimulates the economy. Wage growth returns with increasing revenues, and consumers at all levels tend to spend more quickly; after all, that car or washing machine may cost more next month, so it is better to buy it now.
Because China produces so much of the world’s imports and is likewise a key market for many of the world’s commodity exports, changing producer prices there are reflected throughout global supply chains. Except for a relative few countries with particular economic problems, much of the world has been mired in a stagnant, low-inflation environment since at least the middle of last year, and while China is not the root cause of that in most cases, it has exacerbated the situation.
With China’s PPI growth nearly doubling in a month, and expected to accelerate to as much as 4 to 6 percent by the third quarter of 2017, the natural transfer of higher costs to consumers through Chinese exports—which Beijing is further supporting through yuan devaluation—will give inflation a push all over the world.
The beauty of the change in circumstances is that conditions in China are likely to keep inflation from expanding too much or too fast. Even though the PPI increased, Chinese exports haven’t yet picked up despite the yuan devaluation, and there is still a great deal of excess capacity in many Chinese industries, especially those producing commodities like steel and cement. Those factors will keep PPI growth in check for at least the next few quarters. Chinese monetary authorities have also been working to soak up some of the economy’s enormous liquidity—including a likely increase in interest rates in the very near future, most analysts think—mainly because of the country’s massive debt, now about two-and-a-half times as large as its GDP. Tightening liquidity is naturally deflationary, and so will keep the PPI (and consumer prices as well) from expanding too rapidly.
There is still plenty that could cause chaos in the world economy. The possible impacts of Great Britain’s efforts to extricate itself from the EU are still a matter of speculation, as are the true implications of a Trump administration in the US. Spreading nationalism, which carries with it the risk of greater protectionism, could further dampen already weak global trade, particularly if populists gain control of one or more of the larger economies—France and Italy are most often mentioned as the biggest risks, but they are not the only ones; Germany is worrisome as well, as is most of Latin America. But to the extent it can be considered progress, it seems we can at least now cross “China” off the list of reasons to be concerned about when we think of the global economy.