The deleveraging in China that is being driven in part by its deflationary trap is not abating.
Beijing’s current policies are likely to continue what is shaping up to be an extended period of private sector deleveraging linked to residential and commercial investment.
While the trade war between the United States and China will hurt the Chinese economy on the margin, China is facing a longer-term challenge of what I think will be a decade of economic decline.
The deflation in China, which is being driven by the government’s targeting of high growth and elevated levels of investment to offset deleveraging around the deflated property and banking sector, is likely to continue as manufacturing overcapacity continues to generate an excessive supply of goods.
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That excess supply is being dumped on domestic and global markets, which only creates further tensions as Beijing signals to its trade partners that they will have to accept a smaller share of global manufacturing capacity as the price of China’s long-term and overdue adjustment to its policy mix.
Recent attempts by Beijing to ease price reductions as a way to address overcapacity is a necessary but not sufficient step. Rather, China must rebalance its economy to generate domestic demand, and that means rising unemployment and bankruptcies to clear excess capacity.
In addition, that rebalancing means accepting a flow of investment away from manufacturing to services and a further liberalization of its financial sector following the residential and commercial property-induced period of malaise.
