Wu Ge is the Chief Economist of Changjiang Securities and a director of the China Chief Economist Forum
Key takeaways:
1. Born to the sun. Intuitively speaking, the price reduction of goods is the result that buyers expect, which helps the market to clear. However, prices are also a signal of economic prosperity, and their persistently low levels will in turn affect the expectations of household businesses. Moderate positive price growth is essential for macroeconomic stability.
2. In the case of continuous negative prices, the rate of return on cash is prominent, and the micro main asset side advocates "cash is king". At the same time, the lack of "animal spirits" has made the expansion of the debt side weak. In some cases, there is even an "anomaly" in which nominal debt does not increase, but the real debt burden increases after price adjustment.
3. Historical facts show that it is not easy to get rid of the negative price cycle by relying on market forces alone, and it is often necessary to rely on strong policies and other external forces. Among them, whether the interest cost can be lower than the return on investment of the entity is particularly crucial. Only in this way can the "animal spirit" of micro subjects be stimulated and their active investment and consumption can be promoted.
4. Looking forward to the new year, as local and central economic growth targets are announced one after another, there is objective pressure to promote their realization. Under the baseline assumption that there is no significant improvement in real estate and external demand, it seems that it will be difficult to get rid of negative price growth in the first half of the year. With the countercyclical policy from weak to strong, prices may be expected to turn positive in the second half of the year.
Body:
The price reduction of goods is the result that buyers expect, and it helps the market to clear. However, prices are also a signal of economic prosperity, and their continued downturn in turn affects the confidence of households and businesses.
1. Why should the price be turned positive?
In the case of continuous negative prices, the rate of return on cash is prominent, and the micro main asset side advocates "cash is king". The willingness to save has increased significantly, and the deposit structure has become regular.
Figure 1. Prices are negative, assets are "cash is king"
Source: WIND, the author's calculation Note: The cash rate of return is calculated based on the deposit interest rate and the rate of return on wealth management, and the real rate of return is the ROIC of listed companies. The data excludes trend items.
Prices fall into a low cycle, the confidence of micro subjects often falls, and the "animal spirit" is damaged. There has even been an increase in nominal debt but an increase in the real debt burden. Such a "punitive" mechanism suppresses the expansion of debt and drives prepayment. Although the current interest rate of the existing housing loan is at a low level, the interest rate spread compared with the wealth management yield is still higher than the historical center, and the prepayment of loans by residents is still relatively common.
Figure 2. Prices are negative, liabilities are "passively raised"
Source: WIND, the author calculates
2. When will the price turn positive?
It is not easy to get rid of the negative price cycle by relying on market forces alone, and it often requires strong external policy forces. Only in this way can the "animal spirit" of micro subjects be stimulated and investment and consumption promoted. It was only after Japan's interest rates were significantly lower than the rate of return on investment that year that it was able to emerge from its long-term deflation. At present, the interest cost of listed companies in mainland China is still significantly higher than the return on investment by more than 50 basis points.
Figure 3. Interest costs need to be lower than the real rate of return
Source: WIND, the author's estimation Note: The real rate of return is the ROIC of mainland listed companies, and the interest cost is the interest expense/interest-bearing liabilities of the listed company.
Stronger external demand and a depreciation of the local currency will also help the country to get out of the downturn, but this is not necessarily the case for the mainland's baseline scenario this year. In addition, at present, the pace of fiscal development is slightly backward, and the infrastructure in key debt areas is under pressure. The "three major projects" are expected to open up space, but their intensity and supporting funds remain to be seen. All of these will pose a challenge for prices to get out of the lows.
Figure 4. The role of exchange rates
Source: WIND, the author calculates
III. Basic Conclusions
One is born to the sun. Moderate positive price growth is essential for the stable functioning of the economy. In the case of persistent negative prices, the micro main asset side advocates "cash is king". The lack of "animal spirits" makes the expansion of the debt side weak, and there will be an "abnormal" phenomenon in which the nominal debt does not increase, but the actual debt burden increases.
Second, historical facts show that it is not easy to get rid of the negative price cycle by relying only on market forces, and it is often necessary to rely on strong policies and other external forces. Among them, whether the interest cost can be lower than the return on investment of the entity is particularly crucial. Only in this way can the "animal spirit" of micro subjects be stimulated and their active investment and consumption can be promoted.
Third, looking forward to the new year, with the announcement of local and central economic growth targets, there is objective pressure to promote their realization. Under the baseline assumption that there is no significant improvement in real estate and external demand, it seems that it will be difficult to get rid of negative price growth in the first half of the year. With the countercyclical policy from weak to strong, prices may be expected to turn positive in the second half of the year.
【Author】Wu Ge: Ph.D., Chief Economist of Changjiang Securities. He has worked for a long time in the monetary policy department of central banks and as an economist at the International Monetary Fund. He is the winner of the Sun Yefang Economic Science Award, the Pushan Policy Research Award, the Liu Shibai Economics Award, and the Foresight Cup Economic Forecasting Champion. He is the author of the "Four Steps" of Monetary Economy. Yu Tao, Cao Haiwei, Gao Tong: Researcher of Changjiang Securities. Wei Yihui and Yang Qingliu: Intern researcher.