Tuesday July 5, 2005 - 22:38:02 GMT
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China Deflation Lost In Translation
Several respected-government-linked think tanks in China have recently warned of the rising risk of deflation. In China that is. Talk about skipping stages of development. How does China do from overheating to deflation within months? Never say never. However, the rate of inflation is simply falling, and still some distance from turning negative. While it may be a "lost in translation" problem, the fact is that Chinese officials could be using deflation talk to counter international calls for a yuan revaluation. A higher yuan would add downward pressure on prices and fan deflation...that is if deflation were really a risk. Moreover, by raising the specter of falling price level, Chinese authorities are also implicitly warning that a more freely floating yuan could fall as opposed to rise if there was a serious risk of deflation in China. Be careful of what you ask for. How ironic if China gets around to loosening the yuan band and the currency weakens?
But this is really more about disinflation than real deflation. With a growth rate approaching 9% and an investment spending pace reminiscent of the later stages of the Western industrial revolution, it will take more than a few months of slowing inflation, one interest rate hike (in weak capital market) and a strong yuan (owing to dlr peg) to bring about deflation. In May CPI slowed to 1.8% y/y from a peak last July at 5.3%. But PBOC is looking for 3-3.5% CPI this year (revising down from 4%). While a month of y/y negative CPI can't be ruled out ahead, this is not deflation. Disinflation maybe.
Still it makes more rate hikes unlikely...which could help undermine future efforts to revalue the yuan. I think the more significant story in China's economic development is a potential slowdown that would interrupt the current demand for the world's resources and capital goods. This would hurt success stories like Brazil, Australia and Canada for sure. And even put some serious downward pressure on oil, grains and base metals. But if I had to bet I would look for the next major global slowdown to start in the good old USA where real estate, oil prices, external imbalance, protectionists in Congress and highly leveraged household balance sheet seem far more likely to hit before China's central planners get it badly wrong. Either way, neither story looks very sustainable.
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