The ghost of deflation

Deflation is a difficult trend in an economy to offset. Once it gets hold, it is very difficult to remove, and China has now been in a deflationary phase for several years. Obviously housing prices are a key part of that, but it relates to so many other items and services as well. Although not necessarily prices at your favorite restaurant. Deflation creates an assumption on the part of any buyers that there is no reason to buy right now and better to wait for the lower price to make the purchase. The challenge from the perspective of the system is how to get people to spend money and the usual answer is to make it cheaper to borrow. That is, lower interest rates. But for the China system that is a challenge. Interest rates are already low and lowering them even further may not have too much of a positive effect given the dismal economic outlook. People and businesses are not looking to take on new loans and responsibilities right now. Cutting interest rates of course also impacts on the profitability of the banks, which are the backstop for holding the financial system together.

The banks are holding huge savings deposits, and interest on those deposits are an important source of income for many ordinary people. Not a good move politically to cut the amounts going through to the broad masses. The fundamental solution, proposed by Pettis and many others, is the re-division of assets towards households to give them the confidence to go spend again. But that is pie-in-the-sky fantasy. It’s really hard to see how the current arrangement is shifted and confidence in the future restored. And so deflation continues to haunt the system.

Regardless, here’s wishing you a pleasant weekend with ever inflated happiness.