European disinflation is one of the more interesting economic phenomena of this year. In the euro area, inflation fell to 2% in June and July, following the downtrend in real GDP growth to only 1.4% on a yearly basis.
Some of the disinflation is simply a post-pandemic adjustment following a large inflation shock and tight monetary policy.
But a good portion of it has to do with China exporting its excess industrial production as it seeks to adjust to its own domestic debt and deleveraging era, which in turn requires economies like Germany to accept a lower share of global manufacturing.
In Germany, once the center of manufacturing, real GDP has had zero or negative growth in the 10 quarters since the end of 2022. Unemployment has been increasing slowly over that same period, and, not surprisingly, inflation has dropped to 1.8% at midyear.
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While some of the drop in Germany’s inflation can be explained by the drop in domestic and global demand, its long-run persistence is more than likely the byproduct of China’s exporting its redundant productive capabilities to willing partners.
As China continues to flood its external market with cheap goods, Germany (like the United States in earlier decades) finds itself to be a willing partner, trading its low value-added manufacturing sector for the disinflation of cheap goods.
This is clearly a condition that is not tenable.
