For the past couple of years New Zealanders have experienced the first real bout of inflation in decades.

From food to fuel to almost every service, prices have been going up markedly. The term commonly used is “a cost-of-living crisis”.

In order to try and tame it, the Reserve Bank has been rapidly increasing interest rates. This has led to further pain for households as mortgages repayments have risen significantly.

It seems to be the same the world over. Except it isn’t. In China they may well have the opposite problem: deflation.

Why is this and what might it mean for New Zealand?

COVID’s long shadow and a property market Ponzi scheme

During the COVID lockdowns Western Governments kept their economies going by pumping huge amounts of money into the economy, with furlough schemes and so on.

In China, they did no such thing.

So while Western consumers emerged from lockdown with inflated bank balances, the Chinese were not so lucky. This has led to far less consumer demand inside China.

In addition the gargantuan Chinese property market has been in chaos.

Local authorities depend on selling land to developers (rather than council tax) for much of their revenue.

Home buyers also typically paid most or all of the purchase price upfront, well before the dwelling was actually built.

Developers used this money to finish other properties.

Thus a cycle of continued indebtedness required councils to keep selling land and developers to keep finding new purchasers, grew.

A massive Ponzi scheme was produced.

While the property market in a Western country typically accounts for less than ten percent of GDP, in China it accounts for a quarter.

President Xi was determined to tame this beast and imposed strict debt limits on developers.

This has led to many going bust and people fearing that the property that they have paid for will never be built – so they have stopped paying their mortgages.

With the property market accounting for such a huge proportion of the economy and consumers fearing substantial losses, spending inside China has almost dried up.

To stimulate demand, businesses slash prices. Continual falling prices is what is termed deflation.

As Japan learned in the early 1990s, curing deflation can be extremely difficult: the Government there is still fighting it over thirty years later.

Why buy something today if you believe it will be cheaper tomorrow?

What does this mean for New Zealand?

First and foremost we are an export nation and primarily exporting food, especially diary products.

China is critical to this, so as demand there falls it hurts us.

The milk price is down almost 16%[1] this year (though you might not see this reflected in the supermarket prices, but that’s another story)

Secondly however, China is obviously the workshop of the world.

As prices for countless goods should fall (due to lack of domestic demand), inflation here should fall too.

Economists talk of China “exporting deflation”. So this is not all bad news.

Make no mistake, however, that should China actually follow Japan into a deflationary spiral that would be bad news for our exporters and therefore for New Zealand’s economy.

Finding markets that will pick up the slack left by more frugal Chinese consumers, would not be easy.

President Xi has removed all real advice and support from the Chinese system of Government. It is therefore entirely his responsibility to ensure that the deflation trap is avoided.

For one man to manage this in the world’s second largest economy, would require incredible skill and a significant amount of luck.

[1] Source: https://tradingeconomics.com/commodity/milk