Can China Avoid Japan's Deflationary Fate?

1892 Words Nov 23rd, 2015 8 Pages
Can China Avoid Japan’s Deflationary Fate?
The International Monetary Fund (IMF) recently highlighted that global recession risks in 2016 had risen, but attached a zero percent chance that China would experience this fate. A scenario of an economically contracting China would send deflationary scares spiralling: government bond yields in advanced markets, particularly safe-haven countries, would collapse and perhaps go negative as investors switched their focus to real returns. Although China is unlikely to experience negative growth in the near term, the economy is clearly growing below trend, thereby imparting a deflationary bias on activity. One possible way to eradicate such forces is to export them by weakening the yuan. The decision by the Peoples’ Bank of China (PBoC) to allow the currency to weaken in August sent shock waves around global financial markets, because it highlighted the risks of further escalation in the Great Currency War. Furthermore, the decision to at least contemplate devaluation to solve deflationary issues was viewed as mimicking the policies of the European Central Bank (ECB) and the Bank of Japan (BoJ). The latter is an old hand at fighting the persistence of falling prices, but the fact is that it is still paying a heavy price for failing to contain the forces that were producing a bubble economy, notably a major expansion of bank lending and corporate debt issuance. Japan consequently experienced a so-called balance sheet recession that…
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