China is following in the footsteps of Japan. Deflation happens when you have an aging work force coupled with an asset bubble that bursts spectacularly. 
China Deflation Fears Deepen, With Good Reason
The Wall Street Journal reports While Everyone Else Fights Inflation, China Deflation Fears Deepen.
The article gets some ideas correct but is nauseating for what it gets wrong. Here are some snips and my comments,
WSJ: While the rest of the world tussles with inflation, China is at risk of experiencing a prolonged spell of falling prices that—if it takes root—could eat into corporate profits, sap consumer spending and push more people out of work. Its effects would ripple across the globe, easing prices for some products that countries like the U.S. buy from China, but would also deprive the world of important Chinese demand for raw materials and consumer goods, while also creating other problems.
Mish: Falling prices is a benefit. The problem is excessive debt. I will expound on this point below.
WSJ: Some economists see alarming parallels between China’s current predicament and the experience of Japan, which struggled for years with deflation and stagnant growth.
Mish: The parallels are easy to spot and they were easy to predict in advance.
WSJ: In the 1990s, a collapse in stock markets and real-estate values in Japan pushed companies and households to drastically cut back spending to service burdensome debts—a so-called balance-sheet recession that some see taking shape in China today.
Mish: Correct! The key words are balance-sheet recession.
WSJ: In Japan, deflation first appeared in 1995. Excluding a few respites, it more or less stuck around until the 2008-09 financial crisis. Even today, Japan is battling to sustain higher rates of price growth with ultraloose central bank policies.
Mish: The solution is to write down the debt. Japan refused to do so, and China is following Japan.
WSJ: One textbook response is a massive monetary expansion, lowering interest rates and printing money to spur borrowing and spending, which in theory should trigger more inflation.
Mish: The textbook theory is total nonsense. Look at round after round of QE in Japan and by multiple Fed chairs in the US. QE tends not to create consumer inflation, it creates asset bubbles. It is galling that no central banks understand this key point. Of course, mainstream media and academia all parrots proven falsehoods. Inflation expectation theory is disproved nonsense, yet all of the central bankers believe in it.
WSJ: Data show Chinese companies are reluctant to take on new debt to expand production, while droves of homeowners are choosing to repay mortgages early. Both are signs of weak demand for loans, muffling the effectiveness of interest-rate cuts. A major reason is that many companies and households already have such large debts that they don’t want to add more. Household debt has surged to 1.5 times that of income, far above the level of most developed countries, including the U.S., according to calculations by Jens Presthus, associate director of Global Counsel, an advisory firm.
Mish: Correct! Importantly, it is a massive mistake by central bankers everywhere to keep attempting to jam more debt into a system flooded with it. The Fed has done so too, but not to the same extent as China’s housing bubbles.
WSJ: “Deflation is particularly dangerous when there’s a lot of debt,” said Arthur Budaghyan, chief emerging markets economist at BCA Research.
Mish: Correction, deflation is only dangerous when there is a lot of debt.
Historical Perspective on CPI Deflations: How Damaging are They?
Hello Fed, Bank of Japan, ECB, and Bank of China. It’s not consumer inflation that matters, it’s inflation that matters, specifically debt induced bubbles.
I have been making that case ever since 2006, to no avail. To become a decision maker at the Fed you have to believe total silliness instead of reality.
I have referred to this article before but now is a great time for a refresher course.
Please consider Historical Perspective on CPI Deflations: How Damaging are They?
Of all the widely believed but patently false economic beliefs is the absurd notion that falling consumer prices are bad for the economy and something must be done about them.
The Bank of International Settlements (BIS) took a look at the Costs of Deflations: A Historical Perspective. Here are the key findings.
Concerns about deflation – falling prices of goods and services – are rooted in the view that it is very costly. We test the historical link between output growth and deflation in a sample covering 140 years for up to 38 economies. The evidence suggests that this link is weak and derives largely from the Great Depression. But we find a stronger link between output growth and asset price deflations, particularly during postwar property price deflations. We fail to uncover evidence that high debt has so far raised the cost of goods and services price deflations, in so-called debt deflations. The most damaging interaction appears to be between property price deflations and private debt.
Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive.
Once we control for persistent asset price deflations and country-specific average changes in growth rates over the sample periods, persistent goods and services (CPI ) deflations do not appear to be linked in a statistically significant way with slower growth even in the interwar period. They are uniformly statistically insignificant except for the first post-peak year during the postwar era – where, however, deflation appears to usher in stronger output growth. By contrast, the link of both property and equity price deflations with output growth is always the expected one, and is consistently statistically significant.
The exception to the general rule was the Great Depression but, that was also an asset bubble deflation coupled with consumer price deflation.
Routine Consumer Price Deflation is a Benefit
I am sick of clueless central bankers all pushing for 2 percent inflation when not a one of them understands how to measure it.
For starters, falling prices are a great thing. Your money goes further. Standards of living rise because more people can afford more things. But no. Central bankers all hell bent on producing an outcome where hard earned dollars buy fewer and fewer things.
The Real Problem
The problem is not falling prices, the problem is central banks forcing more and more debt into the system fighting routine CPI inflation until the whole damn thing blows up. That is what happened in Japan and now in China.
Time and time again, the Central Bank of China kept turning to real estate and exports to meet preposterous GDP goals that it set. Every time China’s property bubbles started to lose steam, China went back to the same well.
The average consumer in China put most or all of their savings into property bubbles, typically on leveraged or borrowed money. Many of the buildings do not even exist and many that do are crumbling. But the Chinese leaders kept pushing and pushing and now the bubble appears to be unrevivable.
To top it off, China’s demographics have turned negative. This is the precise setup that hit Japan.
Fool’s Mission
In their foolish attempts to fight routine consumer price deflation, central bankers create very destructive asset bubbles that eventually collapse, setting off what they should fear – asset bubble deflations.
The US would be in the same boat, but US demographics, including net immigration, are in far better shape than China. Also, despite its shortcomings, the US still has the largest, most free, capital markets in the world. China is a centrally planned economy, with no floating currency, an no freedom of speech or movement.
China Intervenes to Prop Up the Yuan
Recently, China intervened in the Forex markets selling US treasuries and buying yuan, hoping to prop up the yuan.
Musings of the Day
All talk about China dumping treasuries is nonsense. Instead of keeping treasuries on its main balance sheet, they are sitting in State Owned Enterprises.
Now China is “dumping” them to prop up the yuan. What a hoot.
What Does China Do With a Dollar That’s No Longer Risk Free?
Please consider my Pettis Q&A post What Does China Do With a Dollar That’s No Longer Risk Free? Buy Gold?
Q&A With Michael Pettis
Mish: Will China now hold more commodities and fewer dollars despite the pro-cyclical nature of it? More Euros or Yen over dollars? More gold?
Michael Pettis (emphasis mine):
1: “Given that so much of China’s “reserves” are now indirect and held by state-owned banks (all the increase since 2017) it’s hard to say what the currency composition of China’s reserves are.
2: “Officially the US dollar is still by far the biggest component, but it is slowly declining.
3: “I expect that this will continue as far as the official reserves go but, as you know, the hard part of reducing the US dollar component of your reserves is figuring out what the alternative should be, and with such high and growing reserves (once you include the indirect reserves at the state-owned banks) that is a very difficult question to resolve.”
Gold-Backed BRIC Silliness
Pettis’ comment on the hard part is precisely why all the discussion on BRICs and a new currency backed by gold or some sort of weighted or commingled currency is hot air.
Launching a BRIC currency is, for now, somewhere between extremely difficult and impossible, in any meaningful sense.
I explain in detail in More Gold Backed BRIC Currency Silliness on Dethroning the Dollar
Thorsten Polleit, chief economist at Degussa, told Kitco, “For making the new currency as good as gold, a truly sound currency, it must be convertible into gold on demand. I am not sure whether this is what Brazil, Russia, India, China and South Africa have in mind.“
Marc Chandler, managing director of Bannockburn Global Forex, told Kitco: “Talk of BRICS gold backed currency seems like an echo chamber. They do not have the gold to back a currency meaningfully. Have we not learned anything from the EMU experience of monetary union without fiscal union. Color me profoundly skeptical.“
Importantly, there are no details to the BRIC announcement. The current discussion involves a “trading currency”.
A “trading currency” is a laughable construct because nations don’t trade, individuals and corporations do. It is the sum of individual and corporate actions that give rise to the concept of national trade deficits.
In essence, the proposed trading currency is a return to Bretton Woods, minus the gold, which surely will not be convertible on demand for the actual traders, individuals and corporations.
Details await. If you are honest about things, and understand trade at all, expect to be underwhelmed.
Let’s return to a point I made above: Despite it’s shortcomings, the US still has the largest, most free, capital markets in the world. China is a centrally planned economy, with no floating currency, and no freedom of speech or movement.
Hoot of the Month
A huge subset of TwitterSphere has actually come to believe that a centrally-planned BRIC, not directly convertible to gold or anything else, at an arbitrary price peg, sponsored by a group of nations that have nothing in common, will crash the dollar.
Imo China is divesting from $ by investing in belt/road projects and, perhaps, funding loans to global south. The amount is not insignificant, slowly declining is even after the enormous and growing surplus with us, maybe 500b/yr. Granted somebody other than China is increasing dollar holdings by that 500+b/yr, but at what point will those also think they have enough such assets as is prudent?
Multi polar might mean a shift to much more balanced trade, I.e. something more sustainable than current. If so, it would be tough for us, used to as we are consuming 1.1T more than we produce. And worse, not clear our arms exports will be in high demand after Ukraine.
I agree they have foolishly blown housing bubbles… what can’t continue will stop. Maybe best option is a partial debt jubilee. We protect banks and bankers from their own stupid, self serving mistakes. Why not homeowners instead? Do the reverse of what Obama did.
Its the same story over and over here. People complaining endlessly about clueless Central Banks.
You are all wasting your time. There is nothing you can do about it. Unless you can manage to become a Central Banker. Then you can “try” to fix everything.
Since you can’t currently change how Central Banks work, the next best thing is to figure out how to profit from what Central Banks are doing.
How about some discussion about that?
Similarly, I cannot change the world’s ever increasing demand for oil, but I can profit from it.
if mish is correct, a big if, than how about shipping companies that move products, from china, to rest of world as they produce more ijunk etc……..at “less dollar and euro amounts per container. more shipping of more junk. i like zim and other shippers too
Thanks for that suggestion.
Sorry, but just laying back and enjoying the raping isn’t quite my cup of tea. I know you think that all that matters in the world is your fiat, but it’s just a fancy piece of barter. But, since you believe you ain’t man enough to do anything; I figure you know best. I’m pretty much done with it all myself. Sucks to be you.
chinese consider and the real estate developers and sales people understand, from china to vancouver to nyc……..that the chinese view a condo as a safe deposit vault in the sky. also the chinese have hedged much of their dollar holdings by entering into long term purchase contracts around the globe for commodity and industrial properties, paying us dollars for the next decade to 100 years for ports, and plantations and mines etc, from sudan to canada…………as folks above point out, mish is not in the know about what the fed actually cares about. they only care about keeping it’s shareholder owners in high cotton. that is the only mandate. jpm and c, and the money centers who own the FED will be given free money to buy on the cheap the country regional banks and their affiliate friends at blackstone……to purchase stuff cheap. when mish thinks he is smarter than the fed, it makes me chuckle and sometimes LOL. the joke is on you, good sir. like many modern men. also, since siracusa in ancient greek sicily started clipping coins, that is currency debasement. i call that inflation. there is good debt and bad debt. when usa borrowed money from europe in 1700s and 1800s to build RR and canals…… that was good debt. to borrow money today to give to MIC to wage war all over the globe, is bad debt. same with GDP. counting war mongering and locks on houses due to crumbling empire, is bad GDP. to count building of income producing products for peace and prosperity, that is good GDP. remember old sport, economics is a very soft science. akin to sociology or theatre or sports marketing………
Now I The CCP elite are scared when I peruse texts like this. Does anyone for certain what the debt mountain is in China. All the massive real estate corporations in China are terminally bankrupt, and only kept alive by the PBOC. Same for massive third world debt to China.
Everything conservative and libertarian pundits want to occur is accomplished by a chnge in the monetary paradigm. A 50% Discount/Rebate policy at retail sale doubles every individual agent’s purchasing power while simultaneously mathematically implementing BENEFICIAL price and asset deflation and potentially doubling the demand for every enterprise’s goods and services. Implement the rest of the policy program of the new paradigm and taxes of all kinds can be drastically reduced or even eliminated. And all you have to do is open your mind enough to see the temporal universe realities the new paradigm will create.
China despite its current economic slowdown will continue to thrive, and if they recognize the new paradigm and imlement it…you better start learning Mandarin.
Central Bankers and the economists they sponsor have a bath tub theory of the economy, full of flows, trickles, plumbing, inputs, drains, and liquidity. They think the trick is to keep the tub full but not overflowing (money).
However, they pay little attention to the composition and distribution of debts, nor to the (intermediate) structures of production. They are clueless, and think that they can drive the economy like a car, left foot tapping the brake pedal, right foot simultaneously gunning the motor … What could go wrong?
Things are worse than they seem:
1. Property has been perpetually bid by Chinese people because in their minds it is the (only) safest place to put your money.
2. Property investments are Chinese social security and retirement funds.
3. Property development has been the main source of local and regional tax revenue.
ES 1M is hugging Oct 2021 close @ 4,597 from above. SPX from below.
In Oct 2008 and in Mar 2020 the Fed had a quickie with your money, behind your
back. No printing.
“The textbook theory is total nonsense. Look at round after round of QE in Japan and by multiple Fed chairs in the US. QE tends not to create consumer inflation, it creates asset bubbles. It is galling that no central banks understand this key point. Of course, mainstream media and academia all parrots proven falsehoods. Inflation expectation theory is disproved nonsense, yet all of the central bankers believe in it.”
I too have wrestled with this year after particularly after the second QE failure by the FED. In other words why would central banks continue to create more and more debt when prior debt, leverage, lack of quality collateral, speculation, fraud, resulted in the so-called Great Financial Crises (GFC).
I have come away that some at the FED did/ and still do believe that QE would bring the US back from the GFC. Why? They don’t understand how markets work because they’ve never worked at a bank or in the real economy. It is that simple.
The other FED cohort that knows that QE wouldn’t work but employed it anyway wanted it to create the wealth effect knowing full well that this would increase the assets for the supply side of the economy and the top 10% decile at the expense of labor, the working class and middle income that primarily earn their income through wage labor. It also penalized those that didn’t/don’t have the wherewithal to save to invest due lack of disposal income for a myriad of reasons some of their own making and others through no fault of their own. This is what happens when the lackeys at the FED that knew better did the bidding of the plutocrats as kleptocrats so the financialization of the economy goes on steroids. The financialization started in the late 70s, through the 00s so the post GFC only made the economy more finance driven.
For regulated capitalism to work, the banks and its proxy must be reigned in. Those at the FED also know this, hence why they don’t effectivelyregulate their clients, the banks.
When the wealthy control monetary policy, fiscal policy, and the issue of debt, own a lot of it and hold a lot of it, they will do anything and everything in their power to not let it go into default because it would mean they would lose control of assets and money flows. Additionally the large debtors hate deflation, and with most large nations being large debtors…..I think the deflationary Great Depression in the US occurred primarily because of a loss of faith in the financial system by the wealthy and everyone else.
Q3 is COLA.
If you are on a fixed income either by pensions or bond investments or both then deflation is fantastic for you. If however, you are still working then deflation also has a tendency to depress wages because the employer can always find someone who will work for less money. At first wages are sticky on the downside but if deflation becomes installed then wages inevitably follow costs. Now debt, aye there’s the rub, for in deflation with stagnant or falling wages debt becomes ever more burdensome and wishing for deflation must give us pause.
The best is to wish for neither excessive inflation nor deflation and to make policies to avoid them.
The Fed will issue the long duration in Q3 in order to ease gov debt and for bank’s “held to maturity” in the red.
QQQ was rising in the last seven months for the banks. Home owners bought 1M/5M
houses, using their stock options as collateral.
The front end is for dividends, the long duration for capital gains. The Fed will issue
the long duration, because Aug, Sept and Oct are usually bearish.
10Y > 5% not in Q3.
Summary:
Deflation is the enemy of debt-holders.
Largest debt-holders are banks and governments.
Deflation is good for the poor.
Hence, rulers and banks are the enemy of the people.
I agree. Japan had an enormous property bubble that popped and ever since people have been paying off mortgages instead of buying things. I think some mortgages are 100 years.
Not sure if China would follow the same path. Japanese people have a lot more pride than others. They agreed to pay off the debt and they’ve been doing it. In China, a lot of debt is on properties that don’t exist yet and may never exist and I think Chinese culture is a lot more forgiving of not paying off a debt.
I think in the US there’s no incentive for paying off debt. People strategically default all the time and no one judges them negatively. People want and demand the government pay off their debt for them.
That’s because people in the US somewhat understand that we are at war with the banks for anything we want or need.
“WSJ: One textbook response is a massive monetary expansion, lowering interest rates and printing money to spur borrowing and spending, which in theory should trigger more inflation.”
This is what it’s come to. Financial media advocating for governments to print money to create more inflation to address economic challenges. This experiment was carried out in the US via QE which led to an incredible transfer of wealth upward while the unwashed masses picked of the tab with a higher cost of living.
Unsurprisingly, this led to anger, resentment and the political upheaval we are dealing with today.
Perhaps that textbook should be tossed in the dustbin of history.
Good Lord! Why do people keep excusing the FED by saying they are making mistakes? Do you have any idea how much money the banks that make up the FED are going to make? How many assets will be owned by the big club that you ain’t in? Jackson was hated by the bankers because he ended their rein of terror on our economy, but Wilson campaigned for the bankers long before he began his selection process for Grand Pooba. The mistake is that people don’t know their history. And it’s coming back to bite hard. Look at this government. Tell me it’s not a joke. How much it resembles the tinpot dictatorships we created in South America. Except Amerikans are far too fat and lazy to survive hard times. And if you’re going to be stupid enough to believe the narrative, you’d better be tough!
You are right James,
How far we have fallen. From Jackson, to Jackson Hole.
**Enough** people don’t know their history.
As I’ve commented on various fed-related Mish posts, the fed is doing their job. They don’t work for the proles, they work for their member banks. There is a lot of nonsense that comes out in the form of studies, tools, and “mandates”, but most of that is just to distract and entertain.
In the end the entity isn’t a bumbling fool moving from one laughable error to the next while the member banks somehow manage to win consistently.
The Great Depression is a hell of an exception.
But yeah, China’s property and demographic situation looks pretty freaking grim.