The National Bureau of Statistics released today CPI and PPI data for December 2014. People’s Dailysummarizes the CPI data, which came in pretty close to market expectations:
China’s consumer prices grew 2 percent in 2014 from one year earlier, well below the government’s 3.5 percent target set for the year, official data showed on Friday. The increase was also below the 2.6-percent growth registered in 2013. Growth in the consumer price index (CPI), the main gauge of inflation, rebounded to 1.5 percent in December from November’s 1.4-percent rise, its slowest increase since November 2009. On a monthly basis, December’s CPI edged up 0.3 percent against the previous month, reversing a downward trend reported since September.
The People’s Daily also summarizes the PPI data, in which November’s 3.3% decline in prices was quite a bit worse than the 3.1% decline the market expected: PPI
China’s producer price index (PPI), which measures inflation at wholesale level, dropped 3.3 percent year on year in December, the National Bureau of Statistics said on Friday. In 2014, the country’s PPI fell 1.9 percent year on year.
Several journalists contacted me asking me to comment on the implications of the latest data, and I thought I would compile for my blog interview questions and responses from two of them. Before doing so I wanted to quote from one more People’s Daily article, in which the writer proposes very automatically a widely-held view about the monetary implications of disinflationary pressures:
China’s consumer inflation remained weak in December, while price declines at the factory gate level continued to deepen, suggesting weakness in the world’s second-largest economy but giving policy makers more room to take easing measures.
Here are the questions and my responses:
- The current data suggests that China is facing deflationary pressures, much like Japan has since the early 1990s. How will this affect the world compared to Japan’s deflation?
It will be very different. Japanese deflation occurred in an environment of fairly robust global growth. The US was just beginning the surge in productivity associated with the spread of information technology. International trade was expanding rapidly. Many developing world economies, and all of Latin America, had emerged from the terrible Lost Decade of the 1980s determined to reform and liberalize their economies. A lot of developing country debt had been written down or was in the process of being written down, and relatively speaking debt levels around the world were low and rising. Commodity prices were low, but stable, and less than a decade earlier, the Fed and other central banks around the world had been fighting off very high levels of inflation. In that environment disinflationary pressures were welcome.
Today, conditions are very different. Non-food commodity prices have declined significantly and will continue to drop a lot more. Because debt levels are extremely high everywhere many countries will be forced into deleveraging, and I suspect  it will be another five years or so before the world seriously engages in the process of restructuring sovereign debt with partial or substantial debt forgiveness. Most importantly, the two main sources of income inequality have not been resolved. First, within the household sector in the US, Europe, China, Japan and a number of other countries, the level of income inequality is nearly as bad as it has even been. Second, at the household level in countries like China and Germany the household share of income is far too low.
This combination has left us with weak consumption, excess savings and excess capacity. Without a major infrastructure investment program in the US, India, or possibly Europe, there simply isn’t enough global demand to absorb the global capacity that has been built up over the last couple of decades. So there is no appetite for disinflationary pressure in today’s global environment, whereas two decades ago the deflationary pressures that Japan might have unleashed were welcome.
I am not sure however that Chinese deflationary pressure is going to matter much to the rest of the world because China is as much a victim as it is a cause of global disinflation. The Chinese economy is simply participating in a greater global environment in which consumption is too low and the resulting excess capacity leaves the private sector unwilling to invest. But Chinese deflation is certainly not going to help.
Where China faces a problem, like many other countries, is in the relationship between debt and deflation. In a deflationary environment unless productivity growth rates are high, it is very difficult to keep the value of assets rising in line with the value of debt. There is a natural tendency for asset values to decline in line with deflation, whereas the nominal value of debt is constant (and, when interest costs are added, the nominal value of monetary obligations actually increases). Of course if the value of debt rises faster than the value of assets, by definition wealth (equal to equity, or net assets, in a corporate entity) must decline. This is why highly indebted countries and businesses struggle especially hard with deflation.
This is a problem for many Chinese borrowers. For nearly two decades, when nominal GDP growth was as high as 20-21% and the GDP deflator at 8-10%, even if they were horribly mismanaged the nominal value of assets soared relative to debt. Very low interest rate – around 7% for preferred borrowers – made servicing the debt almost an afterthought. Under those conditions it was pretty easy to ignore debt costs, and even easier to pick up very bad investment habits. Now that nominal GDP growth has dropped to around 8-10%, and could be substantially lower in a deflationary environment even if growth did not continue to decline, as I expect it will, those bad habits have become brutally expensive.
