Over seven years ago, there was a stunning article published on the front page of China’s state newspaper, People’s Daily. It took the form of a May 2016 interview with an anonymous “authoritative person,” long rumored (but never confirmed) to have been a high-ranking official very close to Xi Jinping. The focus of the interview: the potential Japanization of China.
The interview turned out to be a prescient warning of many of the problems that China has since encountered in the ensuing years—namely, excess leverage, asset bubbles, the deadweight of excess capacity, and the prevalence of corporate zombies. The subtext was clear: if China didn’t address a growing profusion of its own strain of Japanese-like problems, it, too, could succumb to Japan’s infamous prolonged “lost-decade syndrome” of stagnation and deflation.
This week, China reported that its Consumer Price Index for June was unchanged from a year ago. I learned decades ago never to place much emphasis on a single data point, and I underscore that important disclaimer in assessing China’s latest CPI report. At the same time, China’s zero-inflation reading hardly occurred in a vacuum. Unfortunately, it also fits with much of the Japanese-like script of the authoritative person—ongoing debt-intensive growth, the bursting of a massive property bubble, and a state-owned enterprise problem that continues to be plagued by the confluence of excess capacity and disappointing reforms.
Moreover, China sticks out like a sore thumb in what is still a largely inflation-prone world. While disinflation is well under way in the United States, the Federal Reserve is still fighting a stubbornly resistant core inflation rate (CPI excluding food and energy) of 4.8% year-over-year in June—more than double its 2% price stability target. The same is the case in the Eurozone, and even Japan is now experiencing a rare outbreak of increased inflation (above 3% for both its headline and core CPI). For such a globally connected economy, China’s unique flirtation with the dreaded zero-inflation threshold is not something to take lightly.
Clearly, something special is going on in China that bears careful attention. Its Covid policies are a possible culprit. Prolonged rolling lockdowns associated with China’s “zero-Covid” strategy inhibited its recovery and subsequent reflation in 2021-22. But that makes China’s recent disinflationary trends following the lifting of zero-Covid late last year even more disconcerting. This may well reflect the impacts of a disappointing renewed softening in the Chinese economy. That possibility lends credence to the argument that another Chinese stimulus program may well be at hand.
As a student of the lessons of Japan—I taught a course at Yale on that subject for 12 years—that’s what worries me the most. In framing another stimulus, China seems to be leaning back toward Japanese-like policies to counter cyclical pressures on its economy and the price level. It is already injecting support into its still beleaguered property sector and it is reopening the credit spigot at a point when its total nonfinancial debt to GDP ratio is at 297% (as of late 2022, according to BIS statistics)—nearly 43 percentage points above the ratio in 2016, when the authoritative person first issued the Japanization warning.
China is far from the brink of a full-blown Japan deflation scenario. For nearly 19 years (from early 1994 to early 2013), Japan’s overall GDP deflator fell by 16%—the worst outbreak of deflation for any major economy since the Great Depression of the 1930s. During that period, Japanese economic growth slumped to 1%. Needless to say, China cannot afford to flirt with even the slightest nod in that direction. That is what the authoritative person warned of in 2016, a warning that has a decidedly different ring as Chinese inflation now falls to zero.
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