Sunday, May 24, 2015

2015-04 Relative Price Trends

Consumer prices increased 1.5% year-over-year in April, whereas purchasing prices fell 5.5% over the same period. This marks China’s 41st month of economic contraction.

Once again, the financial media is asking all the wrong questions to come to the wrong conclusions. Chinese policy maker’s consumer price inflation target for 2015 is three percent. The wisdom of this target is not questioned. Because the current rate of consumer price inflation is half the government’s target, commentators are calling for more monetary stimulus. According to a recent Bloomberg article:

China’s consumer prices in April rose at half the pace the government is targeting for 2015, suggesting the central bank may need to add to its recent monetary easing to spur a pickup in domestic demand.

The wisdom of closing this gap is not questioned. The same Bloomberg article goes on to state that the People’s Bank of China has already reduced interest rates and required deposit reserve rates twice in the last six months. No reason is given for why this did not have the desired effects, nor is there any explanation of how it will help in the future.

Now that China’s consumer price index has been at or below 2.00% for nine months, even government economists are beginning to sense that China is the new Japan.   According to a recent Reuters article:

Wary about following in the footsteps of Japan, where a decade-long fall in consumer prices has hurt the economy, Chinese officials have warned about the danger of deflation, saying a cooldown in inflation to under 1 percent would raise red flags.

However, the current problem is not that declining consumer prices threaten the economy; the previous over-investment in capacity threatened the stability of the economy. Declining consumer prices are the answer to excess capacity, not the cause.