Trade War

Newsletter 177 - August 13, 2023

Welcome to the 177th edition of Trade War.

While most of the rest of the world struggles with inflation, China is now facing the double whammy of falling consumer and factory gate prices. Despite the ailing economy, Beijing continues to hesitate on launching a full-blown stimulus—perhaps because they know it wouldn’t likely work.

Chinese economists, investment bankers, and company officials have all been told to steer clear from making negative comments about the economy. And domestic law firms must avoid mentioning “adverse changes” in the economy, and instead describe it as “evolving,” when speaking to international investors.

Apparently it’s not enough to just refrain from saying negative things. Bankers and company officials are also being ordered to study Xi Jinping Thought—just like government officials and party members before them.

Long-anticipated tech restrictions were revealed Wednesday, with U.S. president Joe Biden signing an executive order limiting American venture capital and private equity stakes in Chinese firms operating in semiconductors, quantum computing, and artificial intelligence.

And in what appears to be a tightening of control over society related to China’s recent surge in emigration and capital going overseas, Shanghai police have detained the founder and CEO of one of China’s largest immigration consultancies.

• A quick thought: There have always been controls over how China presents itself to the world and restrictions on information. But for years China seemed to have been on a path of greater transparency, even if sometimes it looked like one step forward, two steps back. That certainly was what I saw as a business journalist who covered China’s entry into the World Trade Organization in 2001 and the more than a decade and a half that followed. But that’s so clearly been abandoned by China’s present leaders that the previous era of growing openness should perhaps now be seen as an aberration.

Double whammy of consumer and factory deflation

While most of the rest of the world struggles with inflation, China is now facing the double whammy of both falling consumer and factory gate prices.

Consumer prices dropped 0.3 percent in July compared to the same period a year earlier, the first negative reading in two years. Factory gate prices fell for a tenth consecutive month, down 4.4 percent in July from a year earlier, according to data from China’s National Bureau of Statistics.

Other than a single month at the beginning of the pandemic, consumer and producer prices haven’t both been in deflation since 2009 during the global financial crisis.

“The danger is that if the expectation of falling prices becomes entrenched, it could further sap demand, exacerbate debt burdens and even lock the economy into a trap that will be hard to escape using the stimulus measures Chinese policy makers have traditionally turned to,” reports the Wall Street Journal’s Stella Yifan Xie.

For its part, Beijing is downplaying concerns. Dong Lijuan, a National Bureau of Statistics official, said the decline in consumer prices would be “temporary.”

“With sustained economic recovery, steady market demand expansion, continuous improvement of supply and demand, and gradual elimination of the impact of the high base in the corresponding period of last year, the country's CPI is expected to gradually rise,” reported Xinhua, citing Dong’s comments.

“The reality looks increasingly grim,” says Cornell University economist Eswar Prasad. “The government’s approach of downplaying the risks of deflation and stalling growth could backfire and make it even harder to pull the economy out of its downward spiral.”

“China is in deflation for sure,” Robin Xing, chief China economist at Morgan Stanley, said in an interview on Bloomberg TV. “The question is how long. It’s up to the policymakers—will they react with coordinated fiscal and monetary easing.”

‘China isn’t the market of the future’

“The People's Bank of China is now facing the opposite problem of the Federal Reserve, which has tightened policy for 18 months in a bid to tame soaring prices. Deflation—the trend of prices falling throughout the economy—presents a particularly dangerous trajectory for China, which carries a massive amount of debt,” reports Business Insider’s Phil Rosen. 

“Deflation means the real value of debt goes up,” says David Dollar, a senior fellow at the Brookings China center and a former Treasury and World Bank official in Beijing. “High inflation we know is bad, but it does help manage debt burdens over time. Deflation does the opposite.”

“Dexter Roberts, author of “The Myth of Chinese Capitalism” and a senior fellow at the Atlantic Council, told Insider that much of Beijing's troubles stem from its politicization of its economy,” writes Rosen.

“Embedding Communist Party members in corporations and prioritizing state-run firms, he said, has dragged on domestic productivity, spooked the private sector, and made the country less attractive for foreign investment.”

"A lot of companies now feel China isn't the market of the future," Roberts said. 

But why the aversion to stimulus?

“As China’s data continue to disappoint, there is a persistent theme in much of the outside commentary on its economic woes: that China is for some reason failing to take the ‘obvious’ step of sending stimulus checks to households. The implicit argument is that the US handed out massive subsidies directly to households, got a great post-pandemic recovery and everything turned out fine. China did not deliver subsidies to households, and that’s why everything is very much not fine,” writes Gavekal Dragonomics’ China research director Andrew Batson.

“My suspicion is that part of Chinese policymakers’ reluctance to use direct transfers to households as a short-term stimulus stems from a fear of setting a fiscally destabilizing precedent . . . What started as a one-off policy response could become entrenched as the expected response to any growth slowdown, and would add to government deficits and debt over many years rather than just one.”

Beijing may also fear that pumping more money into the economy won’t make much difference, with companies unlikely to start spending again. As the expression goes, China may end up pushing on a string.

With weak profits, “some companies are reluctant to expand production” reported the Economic Daily in a front-page article [Chinese] on Wednesday. Firms have “put loans obtained immediately into deposits,” and “liquidity is flush in the financial system.”

Economists, bankers, and companies must be cheery

Chinese economists, investment bankers, and companies have all been told to steer clear from making negative comments about the economy.