China’s prices are dropping, and Beijing is looking for answers
The nation that pioneered the invention of paper is currently producing an excessive quantity of it. Shandong Chenming Paper, a major player in China’s paper manufacturing sector, responded to the challenge of overcapacity in a predictable manner: it reduced prices to increase sales and manage excess supply while navigating the difficult market conditions. Conversely, its losses escalated. In the previous month, the firm reported accumulating approximately $250 million in outstanding debts. Creditors initiated legal action, resulting in the freezing of several bank accounts belonging to the manufacturer, as reported.
The challenges faced by the papermaker exemplify the broader turmoil stemming from declining prices in China, where factories grapple with excess capacity and subdued demand. This week, Chinese leaders committed to enhancing economic stimulation efforts, which will involve reducing interest rates and increasing government borrowing. However, there is increasing pressure on Beijing to implement more decisive measures to avert a self-perpetuating cycle of deflation, which could ultimately lead China into a prolonged recession.
For 26 consecutive months, the prices of goods departing Chinese factories have experienced a year-over-year decline, with a notable drop of 2.5% recorded in November compared to the previous year, and indications of a rebound appear scant in the near future. China’s gross domestic product deflator, which serves as a comprehensive measure of price levels throughout the economy, has remained in negative territory for six consecutive quarters, marking the longest period of such decline since the late 1990s.
A prospective trade conflict under President-elect Donald Trump may exacerbate the situation, complicating China’s ability to offload surplus manufacturing output onto the U.S. market, thereby resulting in an accumulation of goods that cannot be absorbed domestically. Concerns are mounting that deflation may be taking root in China. As declining prices erode profitability, firms may defer investments or reduce their workforce, prompting a further contraction in consumer spending. Some consumers may delay their purchases, anticipating further declines in prices.
“It creates a self-perpetuating cycle,” remarked Penelope Prime, founding director of the China Research Center, an Atlanta-based think tank. China’s consumer-price index remains marginally positive, registering a mere 0.2% increase in November compared to the previous year, in stark contrast to the 2.7% rise observed in the United States. The Chinese rate remains significantly lower than the approximately 2% threshold deemed optimal by most central banks for economic stability.
Numerous analysts are closely monitoring China’s producer-price inflation figures, which reflect factory-level pricing, particularly due to the nation’s dependence on manufacturing as a key growth engine. In recent months, Chinese authorities have implemented various measures aimed at stabilizing the economy, which has been grappling with a downturn in the real estate sector and increasing debt burdens across numerous cities. In a bid to bolster local government finances, authorities have reduced interest rates, while last month, policymakers sanctioned a $1.4 trillion debt swap initiative.
This week, China’s 24-member Politburo announced its intention to pursue a more proactive fiscal policy and to adopt a “moderately loose” monetary policy in the coming year—the first instance of such terminology since 2008. The leaders committed to enhancing domestic demand and stabilizing the housing market, a move deemed necessary by some analysts to rekindle inflationary pressures. Despite indications that China’s economy is experiencing a resurgence, current policies appear insufficient to catalyze significant price increases. The primary rationale lies in the fact that the policies have predominantly concentrated on mitigating short-term financial threats, rather than catalyzing a lasting rise in consumer expenditure.
Additionally, Beijing has been augmenting financial support through loans and subsidies directed at Chinese manufacturing facilities. This fosters growth; however, it simultaneously intensifies the issue of surplus supply, contributing to the downward pressure on prices. At Shandong Chenming Paper, management ultimately decided to halt nearly three-quarters of the manufacturer’s production capacity. The firm failed to provide a response to a request for comment.
Other companies have continued to increase their output. According to the National Bureau of Statistics, China’s production of paper and paperboard has increased by approximately 10% year-to-date through October compared to the same timeframe last year. The prices of paper products dispatched from Chinese factories have been on a downward trajectory year-over-year since October 2022.
Other sectors have exhibited a comparable trajectory. William Li, the chief executive of the Chinese electric vehicle manufacturer NIO, remarked during a September conference call with analysts that producers of internal combustion engine vehicles in China have fallen into a “unsustainable cycle or a vicious cycle” of price reductions, which is detrimental to their profitability. China’s vehicle production persists in its upward trajectory.
Certain analysts anticipate that producer prices will remain in negative territory for the foreseeable future, with Nomura projecting a decline of 1.2% in China’s producer-price index, while Macquarie forecasts a 1% decrease by 2025. Bank of America and Goldman Sachs project that producer prices will remain unchanged in 2025. The challenge lies in the fact that once expectations for reduced prices become firmly established, reversing them proves to be quite difficult. Japan experienced a stark lesson in the 1990s as the collapse of real estate and stock market bubbles shifted the focus of consumers and businesses towards debt repayment, sidelining spending and investment, despite policymakers reducing interest rates to near-zero levels. This resulted in approximately thirty years characterized by sluggish growth and ongoing deflationary pressures. Adverse demographic trends proved detrimental.
Richard Koo, an economist affiliated with the research division of Nomura Securities, introduced the concept of “balance sheet recession” to elucidate the economic situation in Japan, asserting that China is currently experiencing a similar phenomenon. In a clear indication of the gravity with which investors are regarding China’s deflationary challenges, 30-year Chinese bond yields have recently dipped below those of Japan for the first time since 2006, as reported by FactSet. Declining long-term bond yields, which exhibit an inverse relationship with prices, indicate that investors perceive China’s economy as unstable, prompting a flight to the relative safety of bonds over riskier assets like stocks.
“The prolonged duration of deflation increasingly solidifies itself within individuals’ anticipations regarding future economic conditions,” stated Eswar Prasad, a professor of trade policy at Cornell University and a former leader of the International Monetary Fund’s China division. “The efficacy of macroeconomic stimulus is increasingly diminishing.” In previous instances of deflation, China implemented more assertive measures. Following the Asian financial crisis of the late 1990s, during which producer prices experienced a continuous decline for 31 months, China initiated a challenging endeavor to address overcapacity. During the tenure of Premier Zhu Rongji, numerous state enterprises underwent closures or reductions in size, resulting in significant layoffs.
Between 2012 and 2016, factory-gate prices experienced a sustained decline over a four-year period, driven primarily by an excess in production of items like tires and solar panels. Chinese authorities have closed superfluous steel mills and various other manufacturing facilities. This time, Xi seems determined to enhance growth by focusing on increased manufacturing output. According to sources acquainted with the deliberations in Beijing, he perceives the U.S.-style, consumption-driven growth model as inherently wasteful. There was no response from China’s Ministry of Finance regarding the request for comment.
Currently, a significant distinction is that the growth of China’s economy is proceeding at a more measured rate than in previous periods. The nation’s GDP experienced an annual growth rate of approximately 7% during the years 2015 and 2016. In the third quarter of this year, China’s economy recorded a 4.6% increase compared to the same period last year, although many analysts anticipate a deceleration in growth for the upcoming year.
Lisa Wang, a sales representative at a textile manufacturer in Zhejiang province, China, indicated that the new tariffs imposed during the Trump administration could exacerbate existing pressures. The factory has been compelled to reduce prices in order to remain competitive amidst a plethora of other manufacturers producing similar bedding items. This price reduction has adversely affected profit margins and necessitated a workforce reduction from approximately 600 employees prior to the Covid-19 pandemic to around 400 at present.
She indicated that her firm is endeavoring to innovate within less crowded market segments, exemplified by a blanket crafted from a fabric that offers a cool tactile experience, aiming to draw in a broader clientele, including prospective buyers from China. Her existing clientele primarily consists of international clients. Amid the uncertainty surrounding Trump’s potential tariffs, she indicated that the company is proceeding cautiously, taking it one step at a time.
