Mr. Jerome Powell must carefully calculate whether to continue raising interest rates or stop when China is trying to revive its economy in a deflationary state.
As US Federal Reserve Chairman Jerome Powell plots the next move by the world's most powerful central bank, he may want to talk to officials in Beijing, Forbes commented.
The reason China returned to deflation in October. Specifically, the country's consumer price index (CPI) fell slightly by 0.2% compared to the same period last year. In addition, producer prices in China also fell by 2.6% in October compared to the same period in 2022. This is the 13th consecutive month of decline in production, raising concerns that many factory owners are cutting prices to compete for market share when there is excess capacity.
"China is an outlier in its post-pandemic reopening as its economy faces increasing deflationary risks rather than inflationary pressures," said Grace Ng, senior economist for Greater China at JP Morgan.
Deflation is defined as a sustained and large-scale fall in the prices of goods and services over a period of time. This is not a positive thing for the economy. Because when consumers and businesses delay spending in anticipation of further price falls, economic problems become worse.
Fed Chairman Jerome Powell in Washington, US on March 22. Photo: Reuters
When China's delegation arrives in San Francisco for the Asia-Pacific Economic Cooperation (APEC) summit this week, they are likely to be bombarded with questions about Beijing's plans to avoid deflation.
APEC has not been so concerned about the weakening of the world’s second-largest economy since the late 1990s. The last time there was concern about China’s decline was at APEC in 1997 in Vancouver, Canada. That year’s meeting took place in the wake of the Asian financial crisis.
A month before the meeting, US and International Monetary Fund (IMF) officials scrambled to prevent currency turmoil in Indonesia, South Korea and Thailand from spreading to China. The US was concerned that Beijing would devalue its currency, too, sparking a new race to the bottom in exchange rates.
And China did not devalue. But when APEC convened, concerns about China's devaluation resurfaced. Adding to the overall problem, Japan - then Asia's largest economy - would be dragged into the crisis.
As leaders sat down at the APEC 1997 summit, they received news that Yamaichi Securities, one of Japan’s legendary four brokerage houses that was 100 years old, had collapsed. In the days that followed, US President Bill Clinton and other Asia-Pacific leaders tried to persuade Japanese Prime Minister Ryutaro Hashimoto to take control of Tokyo’s financial system.
APEC 1997 is an important lesson, as this APEC took place in North America at a time of great concern about China's economic fragility. The country's latest signs of deflation have only added to the worries.
No central banker watches China more closely than Mr Powell. As he prepares to travel to San Francisco for APEC, the Fed chairman says they will not hesitate to raise interest rates again if necessary.
Much of that may depend on China, where growth is slowing and the risk of debt defaults is rising, according to Forbes. Of course, few expect the country’s economy to shrink. But the real estate market there is clearly in crisis.
Real estate accounts for 30% of GDP, making it a clear and present threat to the finances of China’s local governments. As a result, Beijing is shifting from supporting deleveraging to ramping up new stimulus. In addition to cutting interest rates and easing home-buying requirements in major cities, China last month announced a 1 trillion yuan ($137 billion) plan to support the economy.
Still, Serena Chu, senior China economist at Mizuho Securities Asia, forecasts the country's CPI will only grow by around 0.2% this year. "China may face long-term deflationary pressure as domestic demand may not be able to meet idle capacity," she said.
For Mr Powell, it is important to understand the point at which excessive monetary tightening becomes a major threat to developing economies, including China. In 1997, the Fed’s actions affected the entire situation in Asia. The dollar’s rise after the Fed’s aggressive tightening cycle in 1994-1995 unsettled the region.
It is still unclear what the Fed will decide. The latest information from Mr. Powell is that it will proceed "carefully." Some Fed governors such as Michelle Bowman believe that another rate hike is needed to ensure inflation returns to the 2% target.
But pushing China into a more difficult situation could have the opposite effect on the US and the world. According to E&Y’s model, if China’s GDP growth unexpectedly declines by a percentage point below the baseline in 2023 and 2024, weaker trade flows, investment, and tighter financial conditions would shave 0.3 percentage points off US GDP and 0.5 percentage points off global GDP.
The hard landing (rapid and sudden economic downturn) in China in 2015 - 2016 showed the sensitivity of global financial markets to negative developments in this economy, according to E&Y.
At the time, concerns that China's economy was entering a downward spiral rocked global financial markets, leading to a sharp decline in US stocks. Risk appetite, commodity prices and long-term government bond yields also fell.
Phien An ( according to Forbes, EY, JPMorgan )
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