China’s economic woes deepen as deflation takes root, posing an urgent threat to the prospects of the world’s second-largest economy. Despite the government’s attempts to maintain a facade of stability, the latest data reveal a stark reality: consumer price growth is stagnating in vast sectors of the economy, excluding food.
China’s GDP deflator—basically the broadest measure of prices—has been falling for five consecutive quarters, with forecasts pointing to an even bleaker future stretching into 2025. If that holds, it’ll be China’s longest deflationary streak since data was recorded in 1993.
Japan’s experience serves as a stark warning: the longer deflation persists, the more stimulus China will need to avoid a devastating debt-deflation spiral. If the current trajectory continues, China is hurtling towards its own ‘lost decade.’
The danger here is that deflation will spiral out of control. Wages fall, consumers cut spending, businesses see shrinking revenues, and investments halt. Japan knows this vicious cycle all too well from its “lost decades” after the 1990s market collapse. Beijing would rather bury its head in the sand than call it what it is: a deflation crisis.
In a rare moment of honesty, even former central bank governor Yi Gang admitted last week that policymakers must urgently address deflation. The question is why it took them so long to acknowledge the obvious and implement the necessary policy changes.
Private surveys show this is already happening. In sectors favoured by the government, such as electric vehicles and renewable energy, entry-level wages dropped nearly 10% in August compared to their 2022 peak. That’s right, salaries are on the slide even in China’s shiny green industries.
The grim reality is that China’s nominal GDP growth—a crucial measure of wages, profits, and government revenues—rose by just 4% in the second quarter, far below the country’s modest 5% growth target. And with prices dropping across the board—everything from raw materials to construction costs—it’s becoming increasingly clear that China’s economic recovery is stuck in the mud.
And while the leadership clings to its old playbook of stimulating production rather than boosting consumer demand, the rest of the world watches in disbelief. But even as inflation softens and yields on Chinese bonds drop to historic lows, officials are wringing their hands over the risks of an overexposed banking sector.
Despite calls for action, Beijing’s approach is little more than waiting for the storm to pass. And with consumer confidence at rock bottom, that wait could be long. Households are more inclined to save than spend, and even fewer are willing to dive into the housing market.
China is more important than Japan in the 1990s. Due to its massive market, manufacturing prowess, and strong demand for commodities, China plays a critical role in global economic growth. As the world’s second-largest economy, it’s a key driver of international trade, accounting for significant exports and imports that impact countries around the globe.
When China’s economy slows, the ripple effects are felt globally. Reduced commodity demand, weaker imports, and instability in the financial market can drag down growth in emerging and developed economies. China’s growing middle class represents a vital consumer base for multinational corporations. Its continued expansion is crucial for maintaining momentum in sectors ranging from luxury goods to automobiles and technology.
Tenn years of lost decades for China may translate into ten years of slow growth in the rest of the world.