Is China Stuck in a Deflation Trap? Why Low Prices Aren’t Always Good News

Intuitively, the price reduction of goods is the result that buyers expect, which helps the market to clear. However, prices are also a signal of economic prosperity, and their continued low levels will in turn affect the expectations of residents and businesses. Moderate positive price growth is essential for macroeconomic stability.

In the case of continuous negative prices, the rate of return on cash is prominent, and the micro main asset side advocates “cash is king”. The willingness to save has increased significantly, and the deposit structure has become regular. In addition, when the price falls into a low cycle, the confidence of micro subjects often falls, and the “animal spirit” is damaged. There may even be no increase in nominal debt, but an increase in the real debt burden. Such a “punitive” mechanism will suppress the expansion of debt and drive early repayment.

The current round of price declines represented by industrial products is not overcapacity caused by excessive policy stimulus in the early stage. In the past few years, China’s counter-cyclical regulation has been relatively prudent, and many traditional industries have undergone supply-side reforms, and the overall capacity expansion is very limited. Behind the continuous decline in the current price, it is more a reflection of the lack of aggregate demand. In the short term, whether PPI and other prices can turn positive and their upward elasticity depends on the comparison between the expansion of the central aggregate demand policy and the decline in local land revenue.

It is not easy to get out of the negative price cycle by relying on market forces alone, and it often requires strong external policy forces. Only in this way can the “animal spirit” of micro subjects be stimulated and investment and consumption promoted. International experience shows that when the economy encounters a downturn, most countries start countercyclical policy responses. However, whether we can completely get rid of the price downturn depends on whether the strength of policy support can be greater than the “gravity” of the economic downturn. Observed at the monetary level, it means that the real interest rate can effectively be lower than the return on investment of micro agents, or lower than the equilibrium interest rate implied by the “Taylor rule”. It was only after Japan’s interest rates were significantly lower than the rate of return on investment that year that it was able to emerge from its long-term deflation. At present, the interest cost of China-listed companies is still significantly higher than the return on investment by more than 50 basis points. In terms of pace, if the policy can stay ahead of economic changes, it can achieve twice the result with half the effort.

Different from the previous year-end and New Year holidays, there are more nonlinear factors in the current economic operation. In particular, with the significant change in housing price expectations, the value of land and real estate as collateral will be adjusted, which may have a significant impact on the credit expansion of the entire economy. In the 90s, real estate accounted for nearly three-quarters of residents’ assets, and its rapid price adjustment led to a negative cycle of “financial accelerators”. Internationally, housing prices continue to decline, and in the short term, infrastructure may be used to compensate for the credit contraction, but without the stability of collateral value, it will be difficult to substantially get out of the cycle of low prices.

Housing assets account for about two-thirds of China’s total household assets, and a significant decline in housing prices means that the stock of wealth has shrunk, which in turn will inevitably suppress residents’ home buying behavior. At present, the rate of return on real estate has been significantly lower than the interest rate on the stock of housing loans on the debt side of residents, and also lower than the opportunity cost such as the rate of return on wealth management on the asset side, and it is difficult to say that the expectation of buying a house will be reversed spontaneously. If measured by factors such as population and urbanization, China’s future housing demand center may still be more than one billion square meters. However, from an international point of view, if the expectations of micro entities continue to weaken, the housing ownership rate will drop significantly, and residents will delay buying houses and choose to rent more.

In addition, curbing the spread of real estate risks is also related to the systemic stability of the economy. After the adjustment of Japanese real estate started that year, Japanese decision-makers hoped to “exchange time for space” and wait for housing prices and the economy to clear spontaneously. At the same time, they are concerned about moral hazard and are cautious about using public funds to bail out. Affected by this, Japanese non-bank institutions were first damaged, and then spread to banks and the real economy as a whole. According to preliminary estimates, by the end of the year, the funding gap of China’s real estate enterprises was about 4 trillion yuan. Relying only on sales proceeds to make up for the funding gap of “guaranteed delivery of buildings” is still stretched. The progress of “guaranteeing the delivery of buildings”, in turn, affects the confidence of home buyers. Before the risk of real estate enterprises is fully alleviated, it is difficult for the real estate industry as a whole to rebound significantly. In 2024, there may be a slight improvement in real estate, and the construction of affordable housing will contribute part of the investment. Real estate and the economic cycle are highly positively correlated, especially in the real estate downturn, and it is difficult for the economy to rise against the trend. Learning from lessons such as Japan, maintaining a relatively stable real estate sector is crucial for the transition in the downward phase of potential growth such as accelerated population aging. Whether it is the old kinetic energy of infrastructure construction or the new kinetic energy of high-end manufacturing, it is difficult to replace the yearning for a better life of “housing” in “clothing, food, housing and transportation”.

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