Deflation in China is persisting, raising growing concerns domestically and internationally. Beijing’s stimulus policies introduced in September last year have largely been short-lived in financial markets and negligible in the real economy.
Recent data showing disproportionately low bank loan growth relative to the expansion of the money supply suggest the limited effectiveness of the measures. Many have urged the government to take more decisive action, particularly through fiscal expansion, to avoid a deep deflationary spiral akin to Japan’s experience in the early 1990s.
While Beijing’s policy choices remain uncertain, questions abound about the possible endgame for the Chinese economy if no decisive measures are taken. As the core issue lies in low economic confidence stemming from drastic COVID-19 lockdowns — an issue that cannot be resolved through monetary and fiscal expansion — the endgame is more likely to resemble stagflation, characterized by sluggish growth, high inflation and a depreciating yuan exchange rate, rather than deflation.
China has relied on monetary expansion to combat economic slowdown since the outbreak of COVID-19. In December 2021, China’s central bank lowered the benchmark interest rate and the required reserve ratio, while expanding its balance sheet through bond repurchases. After the US Federal Reserve in May 2022 started to raise its interest rate, China’s benchmark interest rate had fallen below its US counterpart.
However, even the Chinese central bank’s most aggressive monetary stimulus measures since the pandemic — introduced in September last year, including further rate cuts and new tools to support the stock market — have failed to deliver meaningful results.
Drawing from the US stagflation of the 1970s and Japan’s “lost decade” of the 1990s, some say that monetary expansion alone is insufficient. They emphasize the need for decisive fiscal policies to boost market confidence and encourage private-sector consumption and investment, especially as the housing market crash has eroded household wealth.
In the eyes of many market observers, Beijing’s fiscal stimulus remains far too cautious.
Weak market confidence in China stems from multiple factors, similar to those observed in the US and Japan’s historical experiences. However, China’s situation is rooted in deeper, more systemic issues. The extreme lockdown measures implemented during the COVID-19 pandemic illustrate that the Chinese one-party state is willing to prioritize other objectives — defined by the Chinese Communist Party (CCP) — over its citizens’ economic welfare.
The lockdown in Shanghai in April and May 2022, even as China’s economic hub, exemplified that trade-off, casting a long shadow over the Chinese economy and signaling unmanageable risks for economic activity. Consequently, Chinese prefer saving over consumption or investment, while foreign capital seeks alternative destinations.
That profound lack of confidence cannot be resolved by monetary expansion combined with fiscal stimulus. As China’s central bank continues printing money, the private sector either increases its savings or looks for ways to bypass capital controls and move funds abroad. That dynamic explains why deflation persists.
Obsessed with sustaining GDP growth, the Chinese government has issued more government bonds, aiming to mobilize savings from the banking system to support refinancing government debts, fund investment projects and boosting consumption. Refinancing government debts merely provides short-term relief for the public sector’s cash flow pressures. Investing in infrastructure projects, while a traditional approach for China, remains an inefficient method of artificially inflating GDP.
Meanwhile, the so-called consumption-boosting measures — such as increasing pensions for retirees and raising financial subsidies for residents’ medical insurance — primarily benefit public sector employees rather than the general public. So far, wage increases in the public sector have been marginal, merely compensating for a fraction of the bonuses slashed in the past few years.
In essence, that approach to GDP growth relies on an impulsive issuance of government bonds. However, rather than stimulating private consumption or investment, the fiscal stimulus can only replace it.
In the long term, the vicious cycle of monetary expansion and growing fiscal debt would likely lead to inflation as more money flows into the real economy. Inefficient government expenditures are unlikely to generate sufficient returns to offset the increased money supply in the market.
Moreover, that cycle incentivizes capital flight, which could further depreciate the yuan exchange rate as domestic and foreign capital exits China. Ordinary citizens, corrupt officials and foreign investors are exploiting loopholes in China’s capital control regime to move money abroad. A declining yuan would, in turn, raise the cost of imported goods and services, further driving up the price index.
Compounding these challenges, deteriorating US-China relations — particularly following the inauguration of US President Donald Trump — are expected to gradually intensify inflationary pressures in China. While fluctuations in China’s expansionary policies could be expected — such as Beijing’s central bank temporarily holding back monetary expansion to preserve policy flexibility as trade tensions escalate — such adjustments are unlikely to alter the broader trajectory. Ultimately, stagflation, rather than deflation, appears to be the endgame. The true test for the CCP regime has yet to unfold.
Charles T. Chou is an adjunct assistant professor in the Center for General Education at National Tsing Hua University.
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