(The economist, Sep 5th 2015)
AS THE world’s biggest exporter, China dominates global shipments of everything from smartphones to sofas. Recently, attention has turned to another Chinese export that appears to be washing up on distant shores: deflation. China’s producer-price index (PPI) has been falling for 41 months straight. Economic growth is slowing; many Chinese industries are suffering from overcapacity; its ravenous appetite for commodities is waning. All that slack must surely be putting downward pressure on prices across much of the world.
It is not the first time that China has been accused of exporting deflation. Before the global financial crisis, China’s impact on world prices seemed a good thing, making televisions and fridges more affordable. Now, it is seen as baleful. The worry is that anaemic inflation is hurting the world economy. Consumers have less incentive to spend, companies have less reason to invest and debts, fixed in nominal terms, remain onerous.
Yet several studies show that China was never quite the deflationary force that it was said to be before the crisis—or at least that it caused both inflation and deflation. By the same token, a closer examination of the data over the past year also suggests that the current, unusually low level of global inflation cannot, for the most part, be traced back to China.
A paper published in 2006 by Tarhan Feyzioglu of the IMF and Luke Willard of Princeton University cast doubt on the idea of China-led deflation when it first emerged as a big exporter. They showed that although Chinese manufacturers helped bring down the price of household appliances in America and Japan, rising Chinese food consumption, a by-product of its growing wealth, contributed to higher food prices abroad. The trends cancelled each other out, with the result that China had only a small, fleeting impact on foreign inflation.
A paper published in 2013 by Sandra Eickmeier and Markus Kühnlenz of Germany’s central bank reached a similar but starker conclusion. They found that the “supply shock” from cheap Chinese goods explained, on average, 1% of changes in consumer prices outside China from 2002-11. The “demand shock” from China’s rapid growth was nearly four times bigger, accounting for 3.6% of changes in global consumer prices, thanks mainly to China’s hunger for commodities. About 95% of swings in global inflation were thus down to non-Chinese factors.
These results shed light on the country’s impact now. One way it might push prices down is by dumping excess output on other countries. Global steelmakers complain, for instance, that China’s state-subsidised companies are undercutting them. But the broader deflationary impact of cheap China-made goods is almost certainly smaller than many assume. The kinds of products in which China excels form a relatively minor part of consumer-price indices. In America, for instance, computers and smartphones account for less than 1% of the index, whereas the share of food is about 15%. Just as cheap Chinese labour did not lead to serious deflation in the early 2000s, so its excess manufacturing capacity is not the main cause of low inflation today.
The demand shortfall arising from China’s slowing growth is sure to be more important. This is especially true of its impact on commodities. However, even this should not be exaggerated. According to the Bundesbank paper, China drove about 11% of commodity-price inflation from 2002-11. That is a big impact for a single country, but it still means that other things such as supply-side constraints and demand from other countries, explained the majority of price changes.
This points to an under-appreciated fact about China’s role in commodity markets: for all the talk of its far-reaching impact, its demand is actually very concentrated. It consumes as much as 60% of the world’s production of certain metals, but accounts for just a tenth of global imports of fuel and a twentieth of food imports. Food and fuel loom far larger in price indices than metals. Although Chinese PPI and commodity prices are closely related, they have been so since China was a much smaller importer (see chart). This suggests that commodity prices help determine the path of inflation in China more than the other way around. China is more a price-taker than a price-maker.
In normal times central banks can deflect deflationary winds from abroad by cutting interest rates. But with rates around much of the rich world stuck near zero, economies are more at the mercy of the weather. That helps explain why China’s current wobbles make investors and central bankers around the world nervous. But once again, the international impact of shifts within China can be exaggerated.
To slow the yuan’s recent fall, for example, China has started to dip into its vast holdings of foreign-exchange reserves, selling off American Treasury bonds. For years, critics warned that China would drive up global interest rates by dumping Treasuries. In practice, though, strong global demand for American assets has negated the effect of China’s selling.
A depreciating yuan should be deflationary for the rest of the world, reducing China’s demand for imports and forcing those competing with Chinese exports to cut costs. That helps explain some of the alarm last month when an abrupt change in the central bank’s policy first sent the yuan sliding. But it has lost just 3% against the dollar in recent weeks. At the end of July it was still 13% stronger than a year before on a trade-weighted basis.
Central bankers and investors are right to keep a wary eye on China. A sharper deterioration in its economy would weigh on commodities, stockmarkets and the yuan, adding to downward pressure on prices. But uncomfortably low inflation is a global phenomenon: it does not carry a made-in-China label.