<strong>The True Cost of China's Falling Prices</strong>

China is grappling with a deepening deflationary spiral, with Bloomberg News analysis revealing price declines more severe than official CPI figures, particularly for consumer goods, and the GDP deflator falling for ten consecutive quarters. This environment of excess capacity, weak demand, and intense price wars is severely impacting corporate profitability, leading to widening losses, thinning margins, and job cuts across sectors, including for major multinational corporations. Consumer confidence remains low, reflected in record-high household savings and declining wages, while current government interventions are perceived as insufficient to address the systemic problem, raising concerns about a prolonged growth slowdown, potential global deflationary exports, and challenges to China's long-term economic trajectory akin to Japan's lost decades.

Analysis

China is experiencing a severe deflationary spiral, with Bloomberg News analysis indicating price drops deeper than official CPI figures, particularly for consumer goods. The GDP deflator has declined for ten consecutive quarters, signifying entrenched deflation across industrial sectors, exemplified by polysilicon prices falling to less than a fifth of their 2022 peak and steel rebar to an eight-year low. This "involution" is characterized by excess capacity and intense, destructive business competition.

This environment is severely impacting corporate fundamentals, with a Bloomberg analysis of 6,000 Chinese companies revealing widening losses, thinning margins, and over a third cutting jobs in 2024. The share of "zombie" firms has increased from 19% to 34% in five years, while capital and R&D spending have fallen for most companies. Consumer confidence is at a low, evidenced by record-high household savings (110% of GDP) and declining wages in private sectors, including a 7% drop in entry-level "new economy" salaries from their 2022 peak.

Beijing's response, characterized by "measured interventions" in strategic industries rather than broad reflation, is largely insufficient to address systemic deflationary pressures. Economists project a third consecutive year of deflation in 2025, raising concerns about a prolonged economic slowdown akin to Japan's lost decades. This also poses a risk of China exporting deflation globally, impacting multinational corporations like Apple and Starbucks, which have already reported significant sales declines.

Key Decisions for Investors

• Investors should re-evaluate their exposure to Chinese domestic consumption and companies heavily reliant on the Chinese market given the entrenched deflationary spiral and weak consumer demand.
• Monitor multinational corporations with significant China revenue streams for continued margin pressure and sales declines, as evidenced by recent performance of companies like Apple and Starbucks.
• Watch for more aggressive and direct fiscal or monetary stimulus from Beijing, as current "measured interventions" are unlikely to reverse the systemic deflationary trend.
• Assess the potential for China to export deflation, which could impact global pricing, trade relations, and the profitability of international competitors.