While Everyone Else Fights Inflation, China Deflation Fears Deepen

Signs of deflation are becoming more prevalent across China, heaping extra pressure on Beijing to reignite growth or risk falling into an economic trap it could find hard to escape.

While the rest of the world tussles with inflation, China is at risk of experiencing a prolonged spell of falling prices that—if it takes root—could eat into corporate profits, sap consumer spending and push more people out of work. Its effects would ripple across the globe, easing prices for some products that countries like the U.S. buy from China, but would also deprive the world of important Chinese demand for raw materials and consumer goods, while also creating other problems.

Prices charged by Chinese factories that make products ranging from steel to cement to chemicals have been falling for months. Consumer prices, meanwhile, have gone flat, with prices for certain goods—including sugar, eggs, clothes and household appliances—now falling on a month-over-month basis amid weak demand.

Most economists think China will probably avoid a deep and lasting period of deflation. Its economy is growing, albeit sluggishly, and the government has unveiled a variety of small stimulus measures that could help more. Earlier in July, Liu Guoqiang, a Chinese central bank official, dismissed concerns that China is slipping toward deflation.

But some economists see alarming parallels between China’s current predicament and the experience of Japan, which struggled for years with deflation and stagnant growth.

In the 1990s, a collapse in stock markets and real-estate values in Japan pushed companies and households to drastically cut back spending to service burdensome debts—a so-called balance-sheet recession that some see taking shape in China today.

Data released Thursday showed industrial profits are sinking and average new home sale prices fell in June.

If China were to tip into protracted deflation, it has another big problem: Traditional methods of fighting it are either unpopular in Beijing, or lack potency due to the country’s heavy debt load and other issues. Beijing is wary of large deficit-financed spending programs that could juice growth and push prices higher, while big debts mean consumers and businesses are reluctant to borrow and spend.

“The big concern is whether the policy tools that they have will have much traction in terms of trying to avert deflation, or deal with deflationary pressures once they arrive,” said Eswar Prasad, a professor of trade policy and economics at Cornell University and a former head of the International Monetary Fund’s China division.

For the global economy, extended deflation in China might help cool inflation elsewhere, including the U.S., since its factories make up such a large share of the world’s goods.

However, a flood of cut-price Chinese exports on global markets could squeeze out rival exporters in some countries, hurting jobs and investment in those economies. Chinese export prices for steel and chemicals fell by about a third over the 12 months through June.

A deflationary spell in China would also likely mean weaker Chinese demand for food, energy and raw materials, which big chunks of the world rely on for export earnings.

“The market is underestimating the deflationary impact on the global economy,” said Frederic Neumann, chief Asia economist at HSBC in Hong Kong.

Consumer prices in the U.S. rose 3% in June from a year earlier, a sharp slowdown from the 8% annual rate a year earlier but still above the 2% rate targeted by the Federal Reserve. Annual inflation in the European Union last month was 6.4% as the region continues to feel the squeeze from high energy and food prices.

In China, annual consumer-price inflation in June was zero. Producer prices fell in China last month by 5.4% from a year earlier.

Subdued consumer spending is one big reason. Some idiosyncratic factors are also at play, including a steep rise last year in the price of pork—a staple in the Chinese diet—that hasn’t been repeated.

But weak price pressures are also a payback of sorts for China’s experience during the Covid-19 pandemic, when exports rocketed thanks to Western demand for gym equipment, home improvement supplies and other goods.

The demand surge helped push Chinese producer prices up 12% between the start of 2020 and their peak in April last year, according to an index calculated by Moody’s Analytics.

When governments lifted lockdowns and Western demand eased, the trend reversed. Producer prices began falling on a year-over-year basis in October and have kept falling every month since.

Chinese factories, which expanded to meet Western demand during the pandemic, now face overcapacity. The hope was that Chinese consumers would step into the breach and soak up excess inventories as export markets dried up. But that hasn’t happened, and as more businesses pivot toward selling into the domestic market, the downward pressure on prices is building.

With global energy and food prices also weaker than before, economists expect overall consumer prices in China to stay nearly flat, or even fall, in the coming months. In addition to many foodstuffs and clothing items, prices have also been falling for electric vehicles, as Chinese automakers and Tesla have slashed prices amid slower sales growth and in an effort to win more share in a crowded market.

China could escape further deflation if growth regains momentum later this year, helped by government stimulus, as some economists anticipate. Nomura economists expect annual consumer-price inflation in China of negative 0.2% in the third quarter, with inflation eventually turning positive again toward the end of the year.

The risk for China is that deflation proves more persistent than expected. Falling prices tend to squeeze spending as consumers await a better deal tomorrow, reinforcing a downward spiral.

The longer it lasts, the more severe its effects become. Entrenched deflation means debts become harder to bear as profits and incomes fall. Companies shed workers to fatten shrinking margins.

In Shanghai, Liu Wang has held off on plans to upgrade his apartment because he is worried about sinking more money into a property whose value he believes could keep dropping.

“The economic condition is highly uncertain now,” said Liu, who works at a logistics firm that is shifting its focus toward domestic business after its export business weakened. In his hometown of Qufu in China’s northeastern Shandong province, demand for homes has been tepid despite a drop in prices, he said.

“The housing bubble is still quite large,” Liu added. “I don’t see any reason why prices will go up.”

In Japan, deflation first appeared in 1995. Excluding a few respites, it more or less stuck around until the 2008-09 financial crisis. Even today, Japan is battling to sustain higher rates of price growth with ultraloose central bank policies.

One textbook response is a massive monetary expansion, lowering interest rates and printing money to spur borrowing and spending, which in theory should trigger more inflation.

But data show Chinese companies are reluctant to take on new debt to expand production, while droves of homeowners are choosing to repay mortgages early. Both are signs of weak demand for loans, muffling the effectiveness of interest-rate cuts.

A major reason is that many companies and households already have such large debts that they don’t want to add more. Household debt has surged to 1.5 times that of income, far above the level of most developed countries, including the U.S., according to calculations by Jens Presthus, associate director of Global Counsel, an advisory firm.

Deflation, or even just the fear of deflation, can make the problem worse. Borrowers worry the cost of servicing their debts is going to rise, so they respond by saving more and spending less.

“Deflation is particularly dangerous when there’s a lot of debt,” said Arthur Budaghyan, chief emerging markets economist at BCA Research.

Colin Saint-Vil got his money education at the dim sum cart, over a steamy plate of pork buns and turnip cake.

A friend offered to pick up the whole tab on her credit card, “for the points.” At the time, six years ago, “for the points” meant nothing to Saint-Vil, now a 30-year-old planning manager in Brooklyn, so he pressed for more details. They lingered over the dim sum meal as a larger conversation unfolded about annual percentage rates, credit-card debt, payment schedules and more.

Millennials and members of Gen Z prefer to seek financial advice from each other than from parents or from financial professionals. They don’t like overwhelming spreadsheets and marketing material written in seemingly foreign languages. They don’t trust big banks and institutions trying to sell them on investment strategies—as many were raised around the late 2000s financial-crisis. And, they are not wrong: There is a lot to be learned from comparing numbers with peers—from sharing salaries to talking out big decisions like home or car purchases.

Saint-Vil said when his father was his age, he had already begun investing in real estate, but with property prices now so high and mortgage rates only just beginning to fall, he said he couldn’t imagine being able to follow in his father’s footsteps. He, like many millennials and Gen Z-ers, describe their finances as “fairly good” these days, though they hold a negative picture of the greater economy, according to a new poll of 18 to 29-year-olds from the Institute of Politics at Harvard Kennedy School.

Millennials are still reeling from the impact of back-to-back recessions, all while large bank closures and investing scams dominate the headlines. Younger people report a feeling of “financial avoidance” exacerbated by high inflation and the pandemic-era budgeting.

As of June 2023, Gallup polling revealed a historically low faith in U.S. institutions, with younger generations voicing high skepticism. According to Gallup, only 9% of respondents aged 18 to 34 expressed “a great deal” of confidence in banks; meanwhile, 47% and 28% said they have “some” or “very little,” respectively.

But when it comes to winning back young consumers, these same financial institutions haven’t quite given up, and are rolling out new outreach programs and robo advisors, some of which have helped bridge a connection with Gen Z and millennials, said Keith Niedermeier, clinical professor of marketing at Indiana University. But many young people still say they prefer do-it-yourself investing platforms like Robinhood and Acorns over traditional advisers at more established wealth-management firms.

Andrew Ragusa, a real-estate broker based on Long Island, blamed the twin problems of low housing inventory and high home prices for postponing younger buyers’ ownership. The median age of a first-time home buyer in the U.S. is 35-years old as of 2023, according to data from the National Association of Realtors. That is slightly down from an record high of 36 in 2022, but still two years older than the median age in 2021, which is representative of an ageing first-time buyer trend.

When he talks with younger clients now, he detects a gloomy sentiment. “They try to be optimistic, but the overall sentiment is ‘This is supposed to be the American dream: we get a house and we get some financial security and I just have to have faith it will all work out in the end.’ But they don’t have faith it will.”

Fear and shame around being able to buy or accomplish as much as one’s parents might have financially can crop up when millennials talk to elders about their financial frustrations, said Jodi Kaus, director of Kansas State University’s student financial planning centre, Powercat Financial. She’s found that lessons and advice from friends are often more constructive.

Kaus leads a peer-to-peer financial planning centre that pairs up students to work through financial issues. She works to pair people with similar backgrounds: graduate students with graduate students or international students with international students. Talking with someone only a few years removed from your current situation means you’re better able to internalize the messages and execute on their advice, Kaus said.

“Early on, parents even say ‘Are you sure students can help my child?’” she said. “And I say ‘I am more than confident that they can help each other.’

Sharing money tips and financial know-how with your friends doesn’t only benefit the asker, Kaus said. In the Kansas State University peer-to-peer group, the advice giver also learns a lot from their own position, because sharing their story and bonding with a peer helps them to build their own confidence and belief in their financial acumen.

Lindsay Clark, a 34-year-old director of external affairs in Washington, D.C., recalls one lesson she shared with a friend carrying student loans from pharmacy school. Clark works at Savi, a student loan platform, and she offered to cook her friend dinner while they sorted through his loan repayment options. Long after they’d cleaned their dinner plates, they sat together at Clark’s kitchen island, lingering over a plate of homemade hummus and chatting about everything from financial goals to Costco card benefits.

“Those conversations blossom from the transparency, and the visibility makes both people feel really good,” she said. “That creates better relationships overall.”

When you’re talking about money issues with friends, Clark said, you’re not artificially inflating your salary or pretending to know more than you do. And most important, you’re not worried about their ulterior motives.

“You feel safe in that conversation, knowing their intentions are good and they’re not trying to make money off of you,” she said. “And that’s going to lead to better results, because we’re working with the reality here.”

Skepticism of pronounced experts and criticism of established financial institutions is especially common among millennials and Gen Z, Neidermeier said. Studies show people across generations are much likelier to take a friend or colleague’s recommendation to heart over that of a faceless institution, he said; people who spend time on social media just have a greater opportunity to source those answers and field questions.

“What people say to each other over the picket fence is what is the most influential,” he said.

At a certain point, however, talking solely to friends and peers for your financial lessons can be very limiting, said Sarah Behr, founder of Simplify Financial Planning in San Francisco. Relying on your social circle can also put a strain on those relationships; no one wants to be responsible for your disappointment when a financial decision that worked out well for them doesn’t fit as well in your own life.

Behr recommends tuning into your own emotional reactions when assessing peer advice: does the road map they followed align with your own financial values? Does it put pressure on you to live outside your means or challenge your personal risk tolerance? If the answer doesn’t feel clear, that could be a time to outsource to a financial professional who has no emotional connection to you or your financial status.

“‘People have been telling me do this, but I just don’t know if it’s the right thing for me’—I get a lot of calls like that,” said Behr.

Saint-Vil said he and his friends share tips on what high-yield savings accounts offer the best rates, and when he did his credit card research, he chose a card recommended by a friend. When it comes time to work with a financial adviser or even one day a wealth manager, he’ll likely work with someone recommended through a peer. Behr said close to 90% of her business comes by way of client referrals.

Since that first conversation over dim sum, Saint-Vil has thrown his own card onto the table at meals and shared his knowledge with other pals who look confused.

“I have a real wide range of friends who are in many different financial places, but I would say a rising tide lifts all ships,” he said.

Julia Carpenter is the co-author, with Bourree Lam, of The Wall Street Journal’s “The New Rules of Money: A Playbook for Planning Your Financial Future,” a personal-finance workbook published this week by Clarkson Potter, an imprint of the Crown Publishing Group.

While Everyone Else Fights Inflation, China Deflation Fears Deepen

Some economists see parallels between China and Japan, where growth stagnated and prices fell for years

Millennials and Gen Z are turning to peers instead of professionals for financial advice. They don’t trust banks, and they are tired of information overload.