Is China Following Japan Into Long Deflation?

More disappointing China data were out. One of the concerns was about China's falling consumer prices and the western media was quick to condemn China of a looming deflation issue.

There's no concrete definition of deflation - Is it marked by a negative Consumer Price Index (CPI) over the course of a year, a month, or a series of consecutive months? For the purpose of discussion, let's assume that China is currently undergoing deflation, as the CPI has fallen by 0.3% compared to a year ago.

Certain analyses have even insinuated that China is mirroring Japan's trajectory into an extended period of deflation, akin to the "lost decades." If this were indeed the case, it would carry substantial implications for the Chinese economy, naturally prompting concern among investors.

But before investors fall into the fear mongering trap, it is basically too early to tell whether a similar "lost decade" is imminent for China. Here are the reasons.

In the first place, the current scenario shouldn't be unexpected, as economists had already anticipated the likelihood of deflation in China. In fact, economists had predicted China's CPI to be at -0.4% for July; yet, the actual figure was slightly better at -0.3%. Therefore, the deflationary figures were well within the predicted range, and the media ought not to exaggerate the situation unnecessarily.

Secondly, this isn't the first instance of China experiencing deflation. Over the past four decades, the country has encountered deflationary periods on four occasions: during the late 1990s, the early 2000s, 2009, and 2021. On each of these occasions, the deflationary phase eventually subsided, with prices ultimately rebounding and trending higher.

Thirdly, even the United States has faced periods of deflation, particularly as it approached the transition to superpower status in the early 1900s. Nonetheless, over the last seventy years, the U.S. encountered only a brief episode of deflation during the Great Financial Crisis in 2008, with inflation typically posing the greater concern. This might be a result of the Fed’s ultra-loose monetary policy.

The key takeaway is that periods of deflation are not enduring, and there exist more instances of countries overcoming such phases than Japan's prolonged entrenchment in deflation.

No one can really be certain that China will become another Japan, and one month of negative CPI is definitely not enough to condemn China to a lost decade. Granted, China may experience more months of negative CPI subsequently but it is not impossible to get out of it.