Trump Tariffs Put China On A Deflationary Razor's Edge

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These are hardly the dynamics that an economy struggling to get households to save less and spend more wants. And yet Trump's tariffs, and the extreme uncertainty surrounding their implementation and timing, might only intensify the deflationary currents roiling Asia's 2025.

China's deflation to date has been mild compared with what Japan experienced after the late 1990s. Wang Dan, an analyst at Eurasia Group, notes that Beijing officials“don't view deflation as a crisis.” Rather, they see weak prices“as a buffer to support household savings during a period of economic transition.”

To be sure, deflation can be benign when falling prices are driven down by productivity improvements, though it's rare and not typical of broad economic deflation. That said, China's rapid-fire deployment of artificial intelligence across the economy could be making efficiency gains not yet apparent in total factor productivity (TFP) statistics, which have long been in decline in China.

Economist Kosuke Motani, author of the 2010 book“The Real Face of Deflation”, notes in Japan's case many viewed falling costs deflation as a stealth tax cut of sorts, offering households a break.

Economist Sheng-Tze Cheng at Peking University also argues that falling prices can help Chinese households by acting as a buffer in times of significant change.

Only time will tell if China is currently experiencing“disinflation” rather than a long-term trend toward deflation. Yet if Japan taught policymakers around the globe anything, it's that deflation concerns can quickly take on a life of their own.

That's a problem that China must not take lightly, economists say. It's now a growing problem for People's Bank of China Governor Pan Gongsheng, who's walking a tight policy tightrope.

Along with navigating the property crisis, Pan is struggling to gauge the severity of the trade-war fallout heading China's way. Pan is also juggling President Xi's big-picture financial priorities.

They include keeping the yuan stable, not incentivizing bad lending and borrowing decisions with excess liquidity, and avoiding a place on Trump's“currency manipulator” list.

Xi and Pan are also trying to avoid shaking up the neighborhood in Asia.“The PBOC is only gradually, and intermittently, weakening the dollar-yuan fix in response to US tariffs , partly to avoid damaging trade relationships with non-US partners,” argues Ashok Bhundia, an economist at the Institute of International Finance.

Yet just like Japan , China is learning the hard way that defeating deflation requires more than just monetary easing. Even more than China needs increased amounts of yuan in circulation, it needs productive uses for the capital.

“China has reached the stage of development where domestic, not external, demand – especially in the non-tradable service sectors – should account for the bulk of aggregate demand,” says Michael Spence, an economist at the Graduate School of Business at Stanford University.

With GDP per capita of US$13,000, Spence says,“China has become an upper-middle-income economy approaching high-income status. So, the non-tradable part of its economy should be approaching the size seen in high-income countries: two-thirds of GDP.

“This means that even very strong demand for China's exports, or strong tradable demand more broadly, could not offset a large shortfall in non-tradable demand. The barriers to Chinese growth primarily reflect weak aggregate domestic demand, largely owing to a shortfall in household consumption,” Spence said.

Unfortunately, he adds, relatively high unemployment, combined with uncertainty about the economy's prospects, has encouraged Chinese households – already big savers by global standards – to double down on precautionary saving.

Yet, he notes that the declining value of real estate, which accounts for an estimated 70% of Chinese household wealth, is having significant negative effects on consumption.

“As the US learned after the subprime mortgage crisis of 2007-10, repairing balance-sheet damage in the household sector is no easy feat, let alone one that can be achieved quickly,” Spence says.

“Subdued real-estate activity,” Spence says,“has also affected local-government finances, which have long depended heavily on land sales and real-estate revenues. Rising fiscal distress among local governments compounds deflationary pressures.”

Analysts at Morgan Stanley write that“we expect Beijing to navigate the challenges with cautious and uneven stimulus policies: still relying on investment in emerging sectors and urban renewal, while gradually shifting policy towards consumption over the medium term.”

Economist Chen Kang at the National University of Singapore argues that Team Xi may have few tools to avoid the worst of Trump's trade war. Over time, though, the costs will mount as rising unemployment depresses incomes and consumption , leading to long-term economic damage.

“The Trump tariffs may be the final push that sends it into deflation” that's hard to reverse, Chen contends.