We’ve had readers vigorously attempt to deny that there is such a thing as overinvestment and too much capacity. Yet we are seeing precisely that pattern play out in China, as its officials increasingly hector companies in a broad swathe of industries to stop cutting prices to preserve domestic market share. The reason for the alarm is that deflation, when it takes hold, is both more destructive and harder to combat than inflation.
China fans are particularly hostile to suggestions that there is anything amiss in the Middle Kingdom. Yet here, the ever-sharper criticism is coming from Xi on down. So a knee-jerk rejection is not a well-informed response.
To remind readers of some of the bad effects of deflation, which is generally the product of the collapse of asset bubbles:
Generally falling prices (obviously the rate of decline will vary by product/service) means companies get lower revenues. They try squeezing suppliers for lower prices, or failing that, cut purchases or may even shut down product lines as their margins become too thin. They also cut prices to try to preserve their competitive position and cover overheads. That can kick off a spiral of what 19th century economists called “ruinous competition,” with railroads a textbook example
Because wages are sticky, workers are more likely to face reduced hours and firings rather than management trying to get them to accept lower pay rates
Falling prices make it rational for consumers to hold off on spending, since purchases are likely to be cheaper in the future
Deteriorating business profits and high unemployment also lead consumers and businesses to retrench, further lowering demand
Price declines and falling wages (or total pay via hours reductions) further impoverish businesses and consumer by increasing the cost of debt (interest and principal payments) in real terms. That has the effect of enriching lenders relative to the rest of the community, since their loans are now worth more in real terms
Deflation also reduces investment. Incurring costs to put new capacity in place when the economy is in a recessionary slide or even falling into a depression is clearly not a good idea. It’s made even worse by the expectation of lower prices when the new capacity comes on line.
As a result, risky assets like stocks and property do badly in deflationary times. Cash and high quality bonds are the best holdings.
Now to some high-level summaries of deflationary conditions from Twitter:
China is dealing with severe deflation:
China’s producer prices (PPI) dropped -3.6% YoY in June, the sharpest decline since July 2023.
This also marks the 33rd consecutive month of factory-gate deflation, one of the longest streaks on record.
Meanwhile, the consumer price… pic.twitter.com/rtU8vllhjq
— The Kobeissi Letter (@KobeissiLetter) July 12, 2025
China producer price deflation intensifies. Now -3.6% YoY. No economist forecast that.
The message for the rest of the world is clear. pic.twitter.com/3OUZ0LTNC8— PPG (@PPGMacro) July 9, 2025
China is bumping up against the "impossible trinity." By choosing not to devalue in response to US tariffs, it also can't ease monetary policy to counter rising deflationary pressure. China has tied its hands. Not devaluing means it chooses deflation…https://t.co/syJg8vmHpA pic.twitter.com/ukJBWHP4QH
— Robin Brooks (@robin_j_brooks) June 29, 2025
Even before the further decline in producer prices, there have been plenty of signs of too much capacity chasing too little demand in China, with the government lacking good options. Recall that we have repeatedly explained that while interest rates can choke off economic activity, putting money on sale does not induce businesses to go out and expand. The only sectors that might react that way are financial firms and other leveraged speculators.
Consider this sighting of ruinous competition from the Economist in early June, Now China’s ultra-cheap EVs are scaring China:
China’s ability to make electric vehicles (evs) cheaply has caused angst in countries with big carmakers, prompting governments to investigate China’s subsidies for the sector and to erect trade barriers. Now, though, it is China’s own government that is worrying about how cheap its producers’ evs are. The race to the bottom shows no sign of letting up, and the industry has become emblematic of some of the broader problems facing the economy.
On May 23rd China’s biggest ev manufacturer, byd, caused shockwaves when it slashed the cost of 22 electric and hybrid models. Now the starting price of its cheapest model, the Seagull, has fallen to a mere 55,800 yuan ($7,700). The move came just two years after byd had originally unveiled the electric hatchback, at a then astonishingly low cost of 73,800 yuan…..
On May 31st China’s industry ministry told Xinhua, the state-run news agency, that “there are no winners in the price war, let alone a future.” The ministry vowed to curb cut-throat competition, which it said harmed investment in r&d, and could cause safety problems. On June 1st People’s Daily, the Communist Party mouthpiece, argued that low-priced, low-quality products could harm the reputation of “made-in-China” goods.
The backlash comes as leaders crack down on unproductive, self-harming competition between firms and local governments that has created overcapacity and lowered profits….
byd’s shares fell after the price cuts and the official pronouncements, amid concerns that the price war will be unsustainable. But to cling to market share, other carmakers cut their own prices. Wei Jianjun, chairman of Great Wall Motor, one of the largest, called the industry unhealthy and invoked the collapse of the property market as a cautionary tale. “Now, the Evergrande of the automobile industry already exists, but it just hasn’t exploded yet,” he told Sina Finance, a news outlet, referring to the world’s most-indebted developer.
Or from the Financial Times on July 8 in China criticises manufacturers over price war as deflation fears mount, before the producer price figures came in even worse than expected:
China has strongly criticised companies and local governments for fuelling overproduction that it blames for driving down prices..
Chinese producer prices have been mired in deflationary territory since September 2022, posing a challenge for policymakers accustomed to relying on manufacturing and exports to drive economic growth.
In articles across state and party media, Chinese President Xi Jinping and other leading officials have attacked what they call neijuan, or “involution”, meaning excessive price competition….
The statements suggest Beijing is growing increasingly wary that surging industrial output, coupled with weak consumer demand at home, is fuelling a race to the bottom in prices that is entrenching deflation and fuelling tensions with the country’s biggest trading partners..
Overcapacity is a sensitive issue for China, which has sought to dispel complaints that its industrial policy has flooded its partners’ markets with artificially low-cost goods…
The mounting chorus of official concern has stoked speculation that Beijing is preparing to unveil for a bout of “supply side reform”, or government intervention into industries to control prices and reduce capacity…
The Chinese Communist party’s leading policy magazine Qiushi conceded last week that “overcapacity” was an issue…
Chairing a meeting of the party’s Central Commission for Financial and Economic Affairs last week, Xi said: “Efforts must be made to regulate enterprises’ disorderly price competition”.
The Economist, at the end of June, again before China reported its 3.6% year-on-year producer price decline, honed in on Xi’s response in Xi Jinping wages war on price wars:
In May the state reprimanded carmakers not for raising prices, but for cutting them….
Carmaking is not the only part of the economy suffering: factory-gate prices fell year on year in May in 25 out of 30 major industries. In eight, including coal-mining and steelmaking, the drop was even steeper than for cars. Across China’s vast industrial machine, average prices have now fallen for 32 months in a row.
Manufacturing investment, especially in high-tech ventures, has been a bright spot for China’s struggling economy in recent years as it weathers a prolonged property crisis. But the rapid decline of industrial prices and profits has raised doubts about the sustainability of even this capital-expenditure boom. Industries such as electric cars, lithium-ion batteries and solar panels were supposed to be new engines of growth that would fill the yawning gap left by the property sector. Now they have also become engines of deflation…
According to Zhao Wei of Shenwan Hongyuan, a Chinese securities firm, the problem most severely afflicts electrical machinery, steelmaking and products such as cement, ceramics and glass, where prices fell faster than the national average last year. These parts of the economy also suffer from unusual amounts of idle capacity. And, by his reckoning, another 15 industries, from cars to tobacco, show some involutionary tendencies, such as weak profit growth, rapid increases in debt, falling prices or low rates of capacity use….
From 2012 to 2016 China suffered four and a half years of falling factory-gate prices….
China’s planning agency imposed production quotas and capacity cuts on oversupplied industries such as steel. It sought mergers and acquisitions to reduce competition. Coal mines were instructed to operate for only 276 days a year. Officials also strictly enforced standards for energy efficiency and pollution, forcing older, dirtier plants to shut. The policy is considered a success.
[Of the efforts so far this time] These interventions are less bold than those of the 2010s. The campaign may be more tentative because many of its targets are different, says Robin Xing of Morgan Stanley, a bank. In 2015-17 the industries suffering from excess capacity were dominated by large state-owned enterprises. They were easy to boss about…
Many industries now suffering from involution are led by less biddable private firms. Electric cars and solar panels, for example, are dominated by sophisticated commercial enterprises, using cutting-edge technology.
The Economist also notes that weak consumer demand is making this picture worse. The fact that China stopped publishing youth unemployment figures when they were ~20% and are still now guesstimated at 17% or even more says some strong deflationary forces are at work generally in China. As I have said, I’ve seen evidence of China exporting deflation into Southeast Asia via the dearth of much in the way of price increases in the two years I have been here.
Readers can tell themselves that China once pulled itself out of a similar situation. But that was before Trump started his small-bore war on China when he took office, which has now become a much bigger dustup. And as indicated, in the earlier supply-side housecleaning, China could pro-actively engage in creative destruction by accelerating capacity cuts in weak and inefficient enterprises. Now the big sinners in the ruinous competition game are often in China’s most productive sectors, even national champions like EVs. So this issue will continue to bear watching.
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The perils of taking the capitalist road…and these people grew up reading books all about these perils. No excuses. Here, us USians were going to the deepest bowels of the library to find these books, when we could find them at all. Could they maybe, in socialist fashion, employ an expansion of the social safety net to free up consumer demand. More and more old folks needing medical care. But, Xi seems to think that taking the socialist road would lead to the masses getting “soft.” Really? Well, there is always military Keynesianism…what the hey, who needs two refrigerators anyway.
Capital, like Nineteen Eighty-Four, is a warning, but too often taken as an instruction manual.
They probably don’t even need to do that, they just need to pay their young/entry-level workers enough money for a reasonable amount of time so they don’t want to engage in 躺平 or laying flat. The highest minimum wage in China is 2,690 CNY a month (up from 2590 a year ago), which comes to about $375 US. Even though 996 is technically illegal, there are firms that still find ways around the law. A 280-290 hour a month work cycle would give an hourly wage of around $1.30/hr, comparable to Mexico’s daily minimum wage of $13.75 USD (278.80 pesos/day) from a labor cost standpoint.
My generous assumption is that economic planners are avoiding doing this because they’re worried unemployment worsens if they do this. Increasing the minimum wage would also result in wage improvements in lower income levels above the minimum wage, but they might be worried firms would then try to avoid paying more by letting go of their least productive workers and making the remaining ones work more. I say generous, because it doesn’t make sense with other economic data.
Despite deflation, Chinese firms’ profitability isn’t falling but increasing so there’s absolutely room to pay people more without making those firms look less attractive to investors by cutting a little bit into those profits. However it’s also possible they know something else that they aren’t divulging that would make further increasing the minimum wage not a viable option.
Hmm… Yeah. As a person with no debt and pretty significant savings, working fewer hours and paying less for goods and services really sucks! I’d love to get back to working eighty hours a week and not being able to afford anything! But hey… That’s just me.
You are assuming you don’t lose your job entirely. Big assumption. Did you miss that youth unemployment in China is 17% to 20%?
Is it possible there really isn’t a blatant pattern here? Greedy over-competition and-consumption naturally kills profit – and irrationally, profit is the holy grail, the very delusion that always drags us up out of a “depression”. Can we ever address the crux of our insanity? A stubborn deflation in China and right on cue WW3 takes off. Repairing and maintaining the natural environment and healthy societies is the solution to all this. Not all our stupid goddamn wars.
A hearty amen, Susan the other.
Here is the FRED Consumer Price Index: Total for China, which doesn’t look like a deflation problem from a 30-year perspective. Note from 1997 to 2003 prices were also more or less flat.
This line of reasoning has always bothered me.
If I want to buy a car, I’m not going to keep taking the bus another 5 years because there’s a chance that BYD’s prices might go down in 2030.
And that’s arguably discretionary spending.
For non-discretionary, no I’m not going to stop buying food even if I believe the price of beans will go down next year.
So you know better than Xi and other top Chinese officials, who had to put shoulder to wheel to reverse the last bout of deflation and are making clear they are very concerned now?
Sorry, your intuition and what actually happens in deflation (when the general economic outlook is also poor) are in two different universes. Read up on the Great Depression or the less intense version in Japan and get back to me.
I’ve see commentators/articles being accused of being anti-Chinese or spouting western propaganda when they were directly quoting official CCP reports, or even statements by Xi himself.
The flip side of the turn to anti-Chinese commentary by much of western media is a rising credulousness among the left to anything that paints China in a good light. Much of the discourse I see now in the alternative/left landscape about China has completely parted ways with anything that resembles critical thinking or the the real world reality of what is happening there.
For me, it’s made some Youtubers’ channels unwatchable.
Agreed. It’s become very hard to trust any Chinese specialist channels as increasingly even formerly good ones develop agendas in one direction or another. And very few ‘generalist’ economics or geopolitical channels really understand enough about what’s going on to do useful analysis. Of mainstream sources, I think only some parts of the business/financial press can be trusted, as they at least attempt to report based on real numbers. Most of the best writing is behind paywalls, and I’m not rich enough to subscribe to too many of them.
I wasn’t questioning that some government officials in China are concerned about deflation, I was questioning some of the reasoning in the post, especially the idea that consumers are all rational actors who will take the bus for 5 years if they think car prices will go down.
I tried finding primary sources, quotes from President Xi about deflation and found this rather dismissive comment being repeated over and over in various venues.
In fact, I did live in Japan several years in the 1990s and the coverage of Japanese suffering in the western press seemed to have no connection to the lives of ordinary people. People’s standards of living were not jumping up the way they were in the 1970s and ’80s, but neither were they decreasing.
It’s about far more than just postponing purchases. In a deflationary scenario, even a very low yield bank account will generate significant real returns – this reduces the incentive to, say, invest in property or even do your existing home up. It becomes economically rational to sit on cash rather than spend or invest money.
but this is really easy to fix, don’t you think? I mean, it’s China not the Depression era USA.
No, deflation is more difficult to remedy than inflation. Go look at Japan and get back to me.
I would just note that a discussion of deflation that ignores the contribution from productivity increases is clearly incomplete, such as lowering costs through automation and efficiency improvements.
For example, deflation has been a consistent feature of computers, monitors, and all (non-DOD) electronics, while the value added to products by electronics is continually increasing. Or, software, where scalability is at a trivial cost—for example, I use MatLab. Ten years ago, it cost $4000 for four licenses, but now it is $1000, presumably because of an increase in market size, as Mathworks can sell 1000 or 10000 at the same “production” cost.
So it seems to me that some level of deflation in some areas of the economy is acceptable (where productivity increases are high) and in other areas is very dangerous (food, but drones and AI are improving productivity dramatically in China), where it drives worker costs and thus consumer purchases downward.
Perhaps the question as to whether it is destructive deflation is whether worker wages are falling.
Again, per my comment above:
1. Youth unemployment in China is 17% to 20%. You seriously think there is adequate demand for labor in light of that?
2. Xi and other top officials are loudly depicting deflation as a problem. You venture to second guess them?
I am normally very keen about your comments. However, I am really amazed at the degree of halo effect cognitive bias around China. The fact that they have done so many things right does not mean that they cannot also have very serious problems.
As I said above, and it bears repeating, I’ve see commentators/articles being accused of being anti-Chinese or spouting western propaganda when they were directly quoting official CCP reports, or even statements by Xi himself.
The flip side of the turn to anti-Chinese commentary by much of western media is a rising credulousness among the left to anything that paints China in a good light. Much of the discourse I see now in the alternative/left landscape about China has completely parted ways with anything that resembles critical thinking or the the real world reality of what is happening there.
Hi Yves, I live in China and have been here for some time. In my extended Chinese ‘family’ through my wife, there are six young folks and four are officially unemployed. I know of similar cases in other families and often enough, they are unemployed by choice as they live by other means. Chinese college graduates, who make up almost half of the youthful working force now, are incredibly picky about the jobs they will accept and will often live off the fat of the land as opposed to taking a job that doesn’t give them the wages or status they want. Also non college grads who are the only children of a family who often own their own home outright and are even retired can also support these unemployed children if they like. My point is, ununemployment figures for youth are pretty complicated and it’s not always easy to know exactly what’s going on, all the best, Mike Liston
it’s a good point. so far as the article goes, the only real concern is the youth unemployment number. but then, as you said, the unemployed are not all in an economically difficult situation.
we can say, long term, the unemployment is a big problem, though. but, more cheap products, i don’t know, it is maybe not exacly a bad thing by itself.
Not having an income = living at home, not getting married or laid (unless the object of your lust provides the shag space). Please tell me how attractive that is.
Liston is providing anecdata. Research from Chinese scholars paints a different picture:
https://www.adb.org/sites/default/files/publication/890896/adb-brief-247-causes-youth-unemployment-prc.pdf
The paper does cite a skills mismatch, as in too many young workers over-educated relative to marketplace needs. That is hardly a problem that is going to go away any time soon. And it gives lots of other contributing factors.
The official statistic for youth unemployment in China is 14.9%, it’s been decreasing for three months in a row now. For comparison, in EU, that would be better than average performance. And for China there are several explanations why the number has remained higher than the 10-11% before COVID epidemic: one of which is the COVID epidemic – the restrictions imposed caused serious disturbances specifically in the domains where youth generally find their first employment.
Also, more and more Chinese young get better education that ever before, and there’s a growing skills vs requirements mismatch causing delays in finding the first job.
So, indeed, the research supports your somewhat anecdotal evidence.
Its more cognitive dissonance about when deflation is good (computers, food, energy, components for manufacturing) or bad (services, housing, commercial products) as in a typical modern economy, prices regularly fall in some products and services (deflationary) whereas others only go up (inflationary – beer and pizza).
Housing is one major area in that it clearly is bad if mortgages go underwater – no idea if Chinese housing is as heavily debt financed as in the US).
Cheaper gas is good for the economy, but cheaper energy drives falling prices if there is competition (or higher profitability in the case of monopoly rents), and that is bad. And I am confused.
Does it now make sense to buy a Chinese car and pay 100% tariff?
I am broadly pro-China cars (from a technical POV)….
but someone with better knowledge should chime in re. safety standards and >100,000 miles (166000 km) reliability, if they are broadly similar to EuroNCAP, etc; reliability of a median Toyota
the median American drives a lot more and at higher speeda than the median Chinese driver
The font of all wisdom on cars – the Dublin taxi drivers I talk to – love their Chinese EV’s, they find them reliable and extremely cheap to run (if you charge at domestic electric rates). One taxi driver told me it cost hime 7 euro a day to do a full days work in his MG (on an overnight charge and another hour charging when he goes home for lunch).
I’ve driven a few as rentals and car shares – BYD’s are impressive, but in overall build quality and design, they are a fraction behind the best Japanese/German/Korean alternatives.
The main reason I would avoid one is that there are multiple reports of cars being stored long term before sale – I’m not sure I’d like to buy a new car thats been sitting at a dock storage area for 18 months.
An investment led model of development will always, by definition, end up in domestic price deflation as you eventually find yourself with more productive capacity than domestic consumers. The way to avoid this is, of course, to export your excess capacity, but only a small economy can maintain this indefinitely – any large economy hits the ceiling of its customers willingness to ruin their own economic ambitions by taking in the surplus. This is the probably the primary reason why middle income trap exists (although its sometimes inflationary if too much borrowing or money printing is used to keep the show on the road). Although Gordon Chang is neither a good economist nor a good faith actor, he made this very point more than a quarter of a century ago in relation to China. It wasn’t a particularly great insight, as plenty of development economists (i.e. those who specifically researched catch up economies) were pointing it out at the time too – and Beijing has always been well aware of it – the supposed transition to a more consumer led, autarkic economy has been a constant in 5-year plans since the turn of the Millennium. The problem has always been that once you create an industrial sector highly dependent on exports, and another even bigger one dependent on pouring concrete over the entire country, taking the short term pain in favour of long term gain gets harder and harder.
As the tweet from Brooks indicates, China is in a particular bind over monetary policy. There are arguments for both cutting interest rates (the traditional way to pump up inflation) and raising interest rates (to stop overinvestment and strengthen the domestic consumer by allowing the Yuan to rise), but both options have major downsides. In the long term, increasing wages, pensions, etc., would help, but in the short term the evidence is that this will actually increase saving and reduce consumption as people wait for prices to fall further. There is no action that can be taken that will not very significantly hurt some major sector of the economy.
The only reason there hasn’t been massive price wars so far is government pressure. To take just the car sector – there are (depending on how you count), between 60 to over 100 car manufacturers in China now. Most of these are not small specialist brands – they are big companies with billions invested. Only a handful can possibly survive. But many (something like 40%) are funded by local governments. So its not just private investors who will get hit hard. In reality, China is full of ‘probably’ insolvent companies, but there is no incentive for anyone to declare them insolvent, so they will just keep on racking up further debts in the hope that something comes up. There is only one big ‘clean’ balance sheet in China – Beijings national budget. At some stage, they will have to spend big to clear up the mess at the local level. But nobody has any clear idea how big that mess is and so far this is a bridge too far for Beijing – but they can’t keep putting this off forever.
Last week Caixin had an excellent story on the direction a lot of investors are taking – scams at various levels. As everyone knows the ‘real’ price of property is higher than the ‘official’ price, its been turned into a money making machine, with local banks, under huge pressure to keep on lending, providing the cash. The longer the distortions in the economy are allowed to persist, the more that scams this become the norm. A version can already been seen in the car sector with the ‘zero mileage second hand car’ scam. There are no doubt many other versions in every other sector of the economy where there is pressure to pretend there are non-existent markets for the products (or bridges) being built.
The situation in China is by no means unique – pretty much every export and investment led high growth economy has (or will) hit the same problem at some stage of development. The US’s probable equivalent was the Long Depression starting in 1873, which brought to an end the rapid growth after the Civil War (depending on interpretation, it lasted from around 7 to 20 years). Germany, Japan, South Korea, and many others had their equivalents – all with different effects and different results. A lot depends on luck – the Japanese and South Koreans probably got lucky in that their transition occurred in the 1990’s, when the world economy was much stronger. What is unique about China is the sheer scale of the country relative to its neighbours and customers – it can’t rely on external factors bailing it out – the only solutions are domestic.
Thanks, nice comment!
The other obvious action that the government can take is to up arm in preparation for America’s war on China. I’m not saying I like this at all, but it’s a sure bet that if Russian and China cooperate then China is going to have a very, very good air defense system that would make America’s “Golden Dome” look like the Israel’s Iron
ColanderDome, and enough anti-ship missiles to sink multiples of the USN.Again, I don’t like this at all, but I assume it’s going to happen.
Military Keynesianism can work up to a point – the problem it doesn’t address is the internal debt load and barely solvent status of dozens of local and regional banks (yes, I know, MMT and all that, but there are multiple reasons why this won’t be applied). The other problem is political – the CCP always, for obvious reasons, tries to ensure the military doesn’t become the real power in the country (as happened in Vietnam and probably Laos). So there are political limits to what can be done.
Btw, Chinese weapons can look great in those videos, but until they are tested in real life, nobody really knows if they are any better or worse than the Russian or Western equivalents. Anyone who claims so is spouting nonsense – there is simply not enough open source data out there for anyone to make definitive judgements. There are plenty of indications, including multiple recent defenestrations of senior officials over the past few years, that all is not well within the sector.
Is this systemic or an artifact of the times ? Some of us remember similar happening to Japan in the 70’s after their rapid industrialisation. The high tech civilisation forming in China is just as wasteful on now limited resources as the remnant of the old left in the West.
At least they are not captive to their real estate market any more like we are and are expanding their military industrial complex unlike us. If it wasn’t for Brad Setser agreeing with this outlook I would be sceptical of people like Robin Brooks.
Will they devalue is the question, would be interesting to see if the Chinese authorities allow their currency to be used in a carry trade.
Imagine a world where the over capacity in China can be exported to third world or near-advanced or even advanced countries with the condition that there should be a technology transfer and an Chinese investment in the importing country production.
Eg – in this imaginary world where everyone has the best intent, China exports solar panels, EV’s to the US with investments in local US production with a minority interest. The US can re-industrialize and there is no deflationary shock to China or an inflationary shock to the US. They export and invest in infrastructure in India, Brazil etc with local majority ownership etc etc.
This would allow the whole world to adopt green tech and technologies of the future where China is leading.
One can just dream of a world where progress of mankind and taking care of the one Earth that we have takes precedence over petty geopolitics.
I usually stay out of Econ conversations, since I know just enough to be extremely dangerous … I typed up a comment, then read “chuck roast” who sums up my comment.
How the F did China end up with a more vicious business cycle than the US? (answered by PlutoniumKun)
Months ago Varoufakis was going on about Trump’s econ people re-creating the Nixon/Volcker put with draconian tariffs, to maintain Strong Dollar while reversing trade debt;
but tariffs for the rest of the world are a distraction, the real target is China. (okay and Iran and Russia and Venezuela and Cuba – hey Cuba is in really bad condition now!)
Seems that it was perfect timing to attack China with tariffs; with deflation on the horizon, removing the US as a consumer of Chinese goods further pushes China into deep deflation … and a way out of the economic morass is war …
So even if China doesn’t want war, the US may be waging economic war as a way to lure China into a military war, and if China “fires the first shot”, it looks like China started the war, when the economic war was the real first shot … but it won’t be recorded that way in the history books (if there is anything left like books or history LOL).
As if military war in Ukraine and the entire Levant, along with brutal sanctions on several countries, weren’t enough? Like VP described above, surely there are cooperative economic plans that “Lift All Boats” LOL.
“Seems that it was perfect timing to attack China with tariffs; with deflation on the horizon, removing the US as a consumer of Chinese goods further pushes China into deep deflation … and a way out of the economic morass is war …”
Additionally, in a simplified big picture view: For all the demographic power of the Global South, the wealth and development are decades away from having the ability to absorb all those Chinese exports fast enough.
This situation stems from no country being serious enough about tackling income inequality across the globe. Too much dependence on the higher earners. Less balance with each passing year.
Hypothetically, the West does not have to go to war with China for “containment”.
Think of how gangstas work in a neighborhood. They don’t have to actually operate all the businesses in the area or stop them from growing. They just make sure they are always in for a cut in some way.
But that’s still a relationship full of bitterness that continues to lead to bad shit happening.
save the real estate market = solve the deflation
China has tried that. It’s only worked to a degree. The main vehicle has been price correction. I gather prices in the Shanghai and Beijing might be pretty close to what could be a new normal but are still inflated in much of the rest of the country.
And they now have industrial overinvestment. That’s a new bubble, albeit not likely on the same scale.
Yves, if you check out the Caixin article I linked to above, you will see there are very weird distortions in the Chinese property market caused by a refusal to acknowledge real prices. There is a well known and apparently widespread scam whereby purchasers are buying property for well below the ‘official’ price in order to borrow the full notional value from a bank. While there is undoubtedly some buying and activity in the Tier 1 cities, there is still a gigantic surplus of low grade housing stock sitting around in most other urban areas. This is one factor that distinguishes the Chinese crash from other well known ones – the Japanese crash (plus the Irish/Spanish, etc) crashes were largely about valuations, in China there is also a simple problem of vastly too much property having been constructed, much of it of very low quality and in the wrong places.
I get the impression that one of the biggest obstacles is the Chinese government’s reluctance to increase its spending on domestic welfare. I imagine another is a possible mismatch between the current mix of industrial output designed as it was for export with the sort of domestic consumption that would enhance citizen wellbeing.
Part of my reluctance to assume China will fail is my sense that its demonstrated capacity to produce much more than it consumes is a less disastrous problem than the US habit of consuming much more than it makes.
I guess we’re going to find out who manages their own problem mix better in the coming decade.
The Chinese economy and society do not behave according to the same overarching socio-economic theories as those nations which have less state direction. (And all those Ricardian economic men are illusory anyway)
For starters China has a hybrid economic model.
Very probably, the western, allegedly free market, economic model needs a lot more state direction, as the climate crisis is not going to be solved by corporate capitalism.
The Chinese fusion model may even prove more applicable to collective co-ordinated problem solving in the 21stC than the current US ‘fuck you, suckers’ neo-feudal approach of 47.
The Chinese are now coming to the end of their 14th 5 year plan. They can intervene in ‘markets’ moreorless as they see fit. Nor do they have global currency pretensions.
Yet assumptions as to the rectitude of the ruling elite’s decision making is another game entirely. There have been long term issues of corruption to balance good intentions.
There are no guarantees that current Chinese leadership ideology will be effective, any more than the invisible hand is more than a raised central digit.
Applying the same sort of “rational” expectations models as are applied to deflation in western economies, so that a falloff in consumerism is seen as a terminal disease and the prediction that there will be unmanageable unemployment etc., is likely to be as accurate for China as the repeated collapse models applied to Japan since 1990.
In any event, there simply cannot be everlasting growth on a finite planet, and deflation that involves a contraction in some economic activity is not necessarily a bad thing. There is a lot of spurious economic activity anyway – nail bars and speculative Forex trading being at two ends of that spectrum.
Distinguishing between inconsequential activity, and the essential productive economy, and acting to ensure the general welfare ought to be easier for the Chinese, which does not mean they will necessarily get it right. There are still those high personal savings rates because of people needing to hedge against the weakness in their social safety net, something that seems paradoxical in a quasi-managed society allegedly, under Confucian principles, for the benefit and well being of the whole population.
I’d love the 4% monthly food bill inflation we seem to have experienced in the UK for years to be a 4% reduction and the constant gouging by food retailers to cease. Would it really hurt Walmart to see a drop in its gross profit margins to below 20% ?
China still has about 40% rural population and equivalent overall employment in farming, with some 300m people engaged predominantly in subsistence agriculture, and approaching 20% of China’s GDP from agriculture.
Given extended family structures and social bonds then much farm labour probably won’t even appear in GDP figures.
Youth unemployment of 15-20% in China is going to have a quite different impact from the youth rate of 15.9% current in the EU, where there is only 4.5% in agriculture, and the urban population is over 75%.
Given its demography, and greater capacity to stimulate internal spending, if China applies the same type of macroeconomic monetary policies as the Bank of Japan has done, and continues to enforce, then there is no reason why the Chinese cannot survive or even benefit from a period of flatlining, certainly better than how purely western economies manage such periods.
Chinese officials do not agree with your point of view, otherwise they would not have worked so hard in the mid-teens to combat deflation and would not again be making clear they oppose it again and intend to reverse it. Why do you think you know better than they do?
For starters, Chinese consumers carry high debt loads compared to what is normal for China’s level of development. As we mentioned at the top, the cost of debt in real terms gets worse under deflation:
https://www.economist.com/china/2025/07/07/why-so-many-chinese-are-drowning-in-debt?giftId=67695822-1b13-4215-990b-3b3f98da977d&
Increased debt burden during stagnant periods is certainly one downside in an economy where so many workers are already highly insecure, especially those on much lower wages in the western provinces, and outside the prosperous coastal cities.
As I commented, somewhat surprisingly, the Chinese social safety net is weaker than might be expected.
Yes, benefit levels are relatively low, and there are gaps in provision.
One option for Xi, with a hesitant economy, is then to provide real growth in benefit levels, as partial compensation, but this is already policy, and has been in recent years, and which incidentally then helps, however marginally, to stabilise demand, in Keynesian fashion.
Deflation is a double edged sword. It is not all downsides.
Debt pressures are going to be counterbalanced by increased purchasing power, and housing rents have either fallen or are flatlining in many Chinese cities.
There are also offsets in reduced input costs for businesses.
Just for one group, there are 250m+ Chinese farmers, not a wealthy sub group, and perennial pressures on food production, so any cost offsets are a positive.
“Why do you think you know better than they do?”…..is an interesting rhetorical device…
I am pretty sure that Xi does not share my personal preference for a managed transition away from the unsustainable Ponzi mentality that drives GDP growth, and for a gradual shift to an economy predicated on balanced resource use. I surmise he is still gaming macroeconomic policy on the basis of pursuing the GDP growth goal, but that does not invalidate either my position or arguments.
Resource consumption overshoot is as much as a problem for China as for the rest of us – in 2026 they will have had 50 years of overconsumption, and with perennial issues of water resource and mineral shortfalls and with heavy reliance on a small arable land resource, and very uneven resource distribution, the Chinese certainly already know it.
One of the issues that is so often overlook in these discussions is that most businesses, especially manufacturing businesses, are monopolistic in their operational structures. Their marginal cost curves are basically downward sloping. This means a cut in production increases the average total cost of each unit. Profit is squeezed regardless of whether the firm cuts prices to save market share or cuts production to keep from cutting prices.
Those downward sloping marginal cost curves comes from having very high fixed costs and most of that fixed cost is usually debt servicing which doesn’t change regardless of price or production for the firm. The only macro solutions are to either fix the demand problem or fix the debt problem. If you don’t fix one of them then the deflation will become a self-sustaining downward spiral until bankruptcy wipes out a whole lot of everything.
Note, if the Chinese government tries to stop deflation by using price controls and production controls… some businesses will likely still find themselves going bankrupt unless the prices are sufficiently high to service their debts at a lower production absent a change in their debt obligations.
A superb read. Thanks you.
“there have been plenty of signs of too much capacity chasing too little demand in China,”
” youth unemployment in China is 17% to 20%”
Dean Baker has for years suggested that the answer for unemployment is to reduce working hours through a range of options.
Decreasing the workweek from 40 to 32 hours for the same pay, mandating long paid vacations, etc .
As a economic simpleton it seems to me this would help the Chinese situation.
Decreasing the work week from 40 to 32 hours with the same pay would require labor costs to increase by 20% to maintain current production levels. (which would be inflationary). This would additionally require an increase in the workforce by 20%.( which would increase demand). Decreased unemployment would allow labor to demand increased compensation (which again is inflationary).
Of course some businesses could go out of business due to increased costs (which would decrease supply). This could be offset by offering subsidies for products that were nationally important.
Increased costs of goods would hurt exports. Would this be the limiting factor in such a solution?
Anyway this could be a step in getting to Keynes’ 1930 prediction that we’d have a 15 hour workweek in a hundred years due to increased productivity. There’s only 5 years left to get there.