Tuesday, March 10, 2009 0 comments

China's CPI goes into negative territory

Of all the countries, the one where we may see severe deflation is China. I'm not calling for it but the risk is high. MarketWatch is reporting that CPI went negative in February:

China's consumer price index dropped for the first time in six years in February, stoking fears of a deflationary trend in one of the world's fastest growing economies.

Data released by the National Bureau of Statistics showed CPI fell 1.6% in February from the year-ago month, with easing food prices contributing to the decline, according to reports.

Economists said one reason for the fall in food prices could be that their prices had jumped last year amid tight supplies in the wake of the snowstorms in several parts of the country.

However, the 1.2% decline in non-food CPI, coming on top of a 0.6% drop in the previous month, is a signal that "deflation remains a threat," Royal Bank of Scotland's Chief China Economist Ben Simpfendorfer wrote in a report.

He wrote that food and residential prices are the major drivers of the CPI in the short-term, with falling wage and raw material costs also likely to permit manufacturers to pass on lower prices to consumers.

...

China's producer price index, meanwhile, fell even more than consumer prices in February, by 4.5% from the year-earlier month.


It's hard to say if this is just a temporary trend or if it is the start of persistent deflation. China has seen mild deflation at times in the last few decades so one shouldn't assume a negative CPI is signalling something new. In fact, the following chart from China Economy Watch shows that CPI was negative as recently as 2002:



The difficulty for investors will be to figure out if the declining prices are the bad deflation or the good deflation. I'm not an economist but here is how I view good and bad deflations. Good deflation is when you have declining prices due to productivity improvements (e.g. decline in personal computer prices in the last 30 years.) Bad deflation when prices drop due to insufficient demand (this generally leads to overcapacity in production, which leads to wealth destruction for owners of production, unemployment, etc.) Developing countries often have bouts of deflation so it's really hard to say except in hindsight.

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