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As the world battles with soaring prices, one country is still holding out against inflation: China. There, order and beauty reigns, alongside moderate inflation. In January, it was running at 0.90% year-on-year – a decline! Core inflation paints the same picture, at a three-year average of 1.1%. Of course, China is not in the same class as the overall champion of deflation, Japan, where underlying “inflation” is at its lowest level for 15 years at -1.1%. But China does not have the same level of growth, or we should say contraction, as Japan. With growth cruising at 5%, China is far from seeing the structural stagnation of its neighbour. Such a low inflation rate in such a strongly growing economy is an enigma, and an economic risk, as well as a stock market opportunity.
The enigma is explained somewhat when we consider that the current level of inflation is around the very long-term average of 1.2% since 2006[1]. Over the last 15 years, the country’s structural inflation has been moderate, despite GDP growth of close to an average of 9%.
One of the prime suspects in such cases is excess industrial capacity. Chinese capacity utilisation has been running at around 77% in recent years. This figure is barely below that of the US, and does not therefore explain such a difference in inflation. Moreover, producer prices in China are currently going the same way as in the rest of the world, with an explosion of more than 9% year-on-year, just as in the US. In the eurozone this is even higher still, at close to 20% currently. The key is therefore consumer prices, and not producer prices.
We could point out a multitude of other reasons. For example, the real unemployment rate is low, anchored at an unwavering 4%, but this could be higher than official statistics indicate. Then again, the credit restriction policy introduced a few years ago to limit the risk of a real estate bubble could have put a brake on consumption generally. And most of all, a savings rate that is still extremely high at close to 30% of disposable income penalises consumption, which is structurally too low in what remains a country of producers. Xi Jinping is well aware of this and is implementing measures to support consumption among the working class.
Whatever the reasons, the economic consequences are considerable, and fairly positive for the rest of the world. First of all, in the current inflationary environment, China is acting as a moderating factor for global consumer prices. Of course, this does not hold true for commodity prices, where China’s needs are unquenchable, or for producer prices, where it is suffering like everyone else. But just think where global consumer price inflation would be if China were to join the rest of the pack.
Secondly, it offers a haven for global bond savings desperately seeking yield. With sovereign bonds still offering a decent return – the 3-month yield is at 1.80%, the 5-year at 2.50% – it is one of the very few countries to offer a real positive risk-free return in local currency terms, i.e. after inflation. Of course, the final return for foreign investors must also take the cost of any currency hedging into account, which is high for investors exposed to very low or negative short rates.
Lastly and most importantly, China’s low inflation level gives it the opportunity to fully mobilise the resources of its central bank to stimulate credit locally, support the troubled real estate sector, and indeed, depreciate the currency, which would have a deflationary effect for all countries to which it exports. Of course, any significant currency devaluation would fuel renewed tensions with the US, although the latter may be sufficiently satisfied with the impact on domestic inflation to not take umbrage.
At a time when practically all central banks are tightening their monetary policies thus creating the conditions for an imminent economic slowdown, China – together with Japan – looks like one of the last available sources of plentiful liquidity should the world need it. This could be either for economic reasons, to counteract an economic downturn, or for structural reasons, such as investing ambitiously in the energy transition, which it is indeed doing with determination.
Will China be the West’s life raft in the ocean of inflation, just as it was its undoing in the wave of corporate relocations?
[1] National Bureau of Statistics of China
Written on 18 February 22 by Olivier de Berranger, CIO, LFDE