As Prices Race Ahead Here, Desolation Grips China
While most nations of the world grapple with soaring inflation rates, China finds itself in the grip of an opposite menace - plummeting prices. This unexpected descent fuels fears of a downward spiral that could spell doom not only for domestic industries but also for foreign enterprises.
A glaring example is the automotive sector. Volkswagen, a global giant, delivered a staggering 12.5% more cars to buyers in the first half of the year compared to the same period last year. Yet, paradoxically, in China, a region where the company now garners over a third of its sales, sales figures took a nosedive. BMW and Mercedes-Benz managed to increase their sales in the Middle Kingdom, but the growth pales in comparison to other markets. BMW's quarterly report grimly acknowledges, "Consumer hesitancy is taking its toll."
This hesitancy pervades various sectors, breeding multifaceted problems. In June, China witnessed a striking inflation rate of 0.0%, and in July, prices plummeted further by 0.3%. This is deflation, the nemesis of inflation, and economists tremble in its presence. This deflation contrasts starkly with Germany's inflation rate of 6.2% in July, the Eurozone's 5.3%, and the United States' 3%. Even inflation-averse Japan recorded 3.3%.
China: A Struggling Economy, Burdened by Debt, and Cautious Consumers
The counterintuitive narrative in China is driven by citizens withholding significant investments. This extends to automobiles, consumer goods like furniture and kitchen appliances, but most significantly, real estate. China's housing market has been gripped by a two-year-long crisis. Real estate corporations had been selling apartments they hadn't even built yet, relying heavily on debt for project completion. However, in 2021, the government imposed stricter financing regulations, leaving many real estate firms floundering.
Consequently, numerous real estate giants have fallen into financial distress, unable to complete projects. Construction giant Evergrande alone reported losses of $100 billion in the past two years. In such an environment, more and more Chinese citizens shy away from investing in real estate.
Furthermore, the frail economy takes its toll. China's stringent no-COVID policies had constrained businesses for years, and while they ended at the beginning of the year, the expected economic boom failed to materialize. Although the unemployment rate hovers around 5.2%, the youth, especially in urban areas, face increasingly dismal prospects. Urban youth unemployment recently surged to 20.4%, figures reminiscent of Spain, Greece, and Romania. For context, Germany's stands at 6.1%.
Sinking Prices and the Abyss of a Vicious Cycle
As the Chinese population clings to their money rather than spending it and energy prices, along with the costs of everyday goods, plummet globally, a deflationary spiral takes root. And, economists' perennial concern begins to materialize – dwindling prices discourage spending on big-ticket items, prompting companies to further reduce prices, perpetuating the deflation.
The crux of the issue lies in the fact that while, in times of inflation, wages eventually catch up and increase, during deflation, they don't decline. Instead, companies struggling to generate revenue are eventually forced to downsize, leading to an increase in unemployment.
This issue is not confined to Chinese businesses but affects anyone seeking to profit from China's billion-dollar market. German automakers mentioned in the article are at the forefront, but even corporations like BASF, Adidas, Merck, and Siemens earn up to a fifth of their revenue in China.
Hesitant Government, Bleak Options, and a Waiting Game
China's government response thus far has been lackluster at best. Recent directives from Beijing to regional authorities instruct them to explore ways to encourage more consumer spending. Viable measures, like stimulus packages that stimulate demand, could be employed, but China's public coffers are heavily burdened by debt, making further financial commitments unappealing.
Another potential tool is interest rate reduction, which would expedite large investments via loans. However, this strategy carries its own set of challenges. Lower interest rates could undermine the strength of the Yuan, a concern for China as the currency has fallen approximately 12% against the US Dollar and 14% against the Euro since its peak in spring 2022. The weakened currency could hurt China's export-oriented industries, and thus, Beijing is reluctant to court additional vulnerabilities.
The likeliest scenario is that China will weather the crisis, intervening with state funds only to support the most critical situations, such as threatened banks and corporations. This tactic mirrors the approach China adopted in 1998 during a deflation phase amidst the Asian crisis.
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