Why does the price data show that deflation deepens with monetary easing?

Executive Summary:

All price data for November showed a deepening trend towards deflation. In recent years, our money supply, credit supply, and fiscal expenditure have all expanded at about twice the economic growth rate. Deflation, which accompanies the expansion of the supply of monetary, credit, and fiscal policies, is a complex atypical deflation. Atypical deflation and liquidity traps with Chinese characteristics stem from China's unique economic system and economic growth model. Atypical deflation combined with liquidity traps with Chinese characteristics will have a non-negligible negative impact on China's medium- and long-term asset prices such as bonds, exchange rates, real estate, and stocks.

1. All price data for November showed a trend of deepening deflation

In November, the national consumer price index (CPI) fell by 0.5% year-on-year. Among them, food prices decreased by 4.2 per cent, non-food prices rose by 0.4 per cent, consumer goods prices fell by 1.4 per cent, and service prices rose by 1.0 per cent. The CPI fell by 0.5% month-on-month. Among them, food prices decreased by 0.9 percent, non-food prices decreased by 0.4 percent, consumer goods prices decreased by 0.5 percent, and service prices decreased by 0.4 percent.

In November, the national industrial producer price (PPI) fell by 3.0% year-on-year and 0.3% month-on-month. Among them, the ex-factory prices of means of production fell by 3.4 percent year-on-year and 0.3 percent month-on-month, and the ex-factory prices of means of subsistence fell by 1.2 percent year-on-year and 0.2 percent month-on-month.

In November, the purchase prices of industrial producers fell by 4.0 percent year-on-year, and by category, except for the prices of non-ferrous metal materials and wires, which rose by 2.6 percent year-on-year, the purchase prices of other categories fell by 0.4 percent to 7.8 percent, and the purchase prices of industrial producers fell by 0.3 percent month-on-month. Prices of wood and pulp, ferrous materials, construction materials and non-metals rose by 0.6%, 0.3% and 0.1% month-on-month, respectively, while prices of other categories decreased by 0.1% to 1.3% month-on-month, respectively.

All price indices fell by a deeper margin than in October. The year-on-year decline in CPI deepened to 0.5% from 0.2% in October, and the month-on-month decline deepened from 0.1% to 0.5%; The year-on-year decline in PPI widened to 3% from 2.6% in October and the month-on-month decline widened from 0% to 0.3%, while the year-on-year decline in producer purchasing prices widened to 4% from 3.7% in October and the month-on-month decline widened from 0.2% to 0.3%.

Readers who do not study economic issues may lack a basic understanding of the data that the CPI fell by 0.5% year-on-year, because everyone feels that except for the pork price transfer of about 10 yuan, it feels a little stronger, and the other price changes are not obvious.

We often ridicule Japan's lost 30 years because the Japanese economy has stalled and is in a long-term deflationary state. However, in 1990~1999, that is, in the 120 months of the first 10 years that Japan lost, there were only 6 months in which the CPI fell by more than 0.5%, and the first time appeared in the fifth year after it fell into deflation, that is, in October 1995, and 3 of them were concentrated at the end of 1999.

2. In recent years, our money supply, credit supply, and fiscal expenditure have all expanded at about twice the economic growth rate

It should be said that there is nothing to hide, due to the contraction of domestic and external demand, there is a serious oversupply, and prices are falling across the board. And all price indices in November showed a deepening of deflation.

Generally speaking, demand exceeds supply, prices rise, oversupply and prices fall. In economic principles and common sense, the decline in prices is largely due to monetary tightening, contraction of credit supply, and reduction of fiscal spending, resulting in pent-up demand and insufficient demand-type deflation.

But surprisingly, this is not the case with the formation of our deflation. Because we have been in the midst of a lot of monetary easing and fiscal stimulus in the past few years.

In the first three quarters of 2023, China's GDP grew by only 4.9% at current prices, but as of October, the stock of social financing increased by 9.1% year-on-year, the currency M2 in circulation increased by 10.3% year-on-year, the balance of government debt increased by 14.3% year-on-year, and the national fiscal deficit is expected to reach 4.88 trillion yuan, an increase of 25.8% from the previous year. At the same time, the deficit ratio will also increase from 3% in the previous year to around 3.8%.

In fact, our monetary easing and fiscal expansionary policies have not led to commensurate demand growth and economic growth, not just this year, but for several years.

Compared with 2019, as of October 2023, M2 increased by 45.1% from 199 trillion yuan to 288 trillion yuan, the stock of social financing increased by 48.8% from 251 trillion yuan to 374 trillion yuan, the balance of government debt increased by 79.4% from 38 trillion yuan to 69 trillion yuan, and the overall fiscal deficit increased from 5.5 trillion yuan to 9 trillion yuan in 2022, an increase of 62%.

However, in exchange, GDP only increased by about 26.5%, fixed asset investment increased by 17.2%, total household consumption expenditure increased by 24.6%, and commercial housing sales fell by 26.7%.

In April, I said in the article "Economic Signals for March Price Index: We Are Transitioning from Long-Term Low Inflation to Deflation" that we are heading for deflation.

But some people believe that credit growth and fiscal expansion are not deflationary. In fact, credit growth and fiscal expansion, accompanied by falling prices, are more troublesome forms of deflation.

Recently, the National Development and Reform Commission (NDRC) expressed its view that China's economy will go against the current this year, developing in waves and moving forward in twists and turns. In fact, the overall trend of the human economy must be improving, but the waves and twists and turns implicitly mentioned by the NDRC are deflation, and the twists and turns are inflation.

3. Deflation that accompanies the expansion of monetary, credit, and fiscal policies is a complex atypical deflation

In a typical economic context, deflation is a general decline in the prices of goods and services, usually associated with a contraction in the supply of money and credit in the economy. During deflation, the purchasing power of money rises over time.

It has to be said that the current deflationary trend on the mainland does not meet the typical definition of deflation. This is because the prices of goods and services have generally fallen, but not in the contraction of the supply of money and credit, but rather in an anomaly that has developed during the expansion of money and credit.

Theoretically, deflation is a state in which the prices of goods and services fall or cannot rise due to a persistent oversupply. There are theoretically two causes for this state.

One is the decrease in the amount of money in circulation, resulting in an oversupply and a fall in prices on the demand side due to the contraction of the monetary aggregate due to the reduction of nominal income and purchasing power when the supply side is not reduced. This is a typical deflationary state.

The other is that the currency in circulation continues to increase, but subject to the economic system, economic policy and economic development model, the monetary flow structure increased by monetary easing and fiscal expansion is not synchronized with the stock structure, and the proportion of money flowing to the supply side continues to be greater than the proportion of flowing to the demand side, resulting in the increase in money on the supply side continues to be greater than the increase in money on the demand side, resulting in a gradual and serious oversupply and price fall.

In the initial stage of the above state, it will manifest itself as low inflation, and if the structure of incremental money flow cannot be adjusted in time, and the relationship between supply and demand continues to deteriorate, it will evolve into deflation. In the eight years after the Asian financial crisis, as well as in recent years, our economic situation has been due to the fact that the proportion of investment and consumption has been out of balance due to the substantial increase in incremental money, and the proportion of funds flowing into the supply side through investment has become larger and larger, and the proportion of funds flowing into the consumption side has become smaller and smaller, resulting in the continuous weakening of residents' consumption capacity and the deterioration of the relationship between oversupply and demand relative to the supply side, which continues to lead the growth, so that the price increase has continued to fall from a continuous decline to a decline.

Our current economic situation falls into this category. This is an atypical type of deflation.

Fourth, atypical deflation and liquidity traps with Chinese characteristics stem from China's unique economic system and economic growth model

Fifth, atypical deflation and liquidity traps with Chinese characteristics will have a non-negligible negative impact on China's medium- and long-term asset prices such as bonds, exchange rates, real estate, and stocks

Parts 4 and 5 are to be continued, as Saburo plans to use the latest financial data to explain this conclusion.

If you are interested, please pay attention to Saburo's economic analysis article the day after the central bank released the financial data for November, for which Saburo will give a little-touched and easy-to-understand explanation of deflation.

[Author: Xu Sanlang]