China’s GDP Nightmare Could Be Dream For Jerome Powell

The escalating deceleration of China's economy will provide Federal Reserve Chair Jerome Powell with an opportunity to conceal his previous errors.

While Jerome Powell endeavors to control the most severe inflation witnessed in many years, an unexpected source, China, is providing support to the Federal Reserve chairman.

The unexpected deceleration in the largest economy in Asia has taken people by surprise. Half a year ago, the widely accepted belief was that China's recovery from the Covid-19 period would significantly elevate the worldwide gross domestic product and lead to a notable increase in inflation.

On the contrary, achieving China's 5% growth target seems increasingly unlikely due to the declining property sector and fragile consumer trust. Additionally, there is a risk of deflation in Chinese consumer prices, further supporting the argument for Beijing to implement new measures to stimulate demand.

China's lackluster performance as we enter the latter part of 2023 is quite an undesirable blow to the economy. This unexpected turn of events is causing a reconsideration of the expected path for oil prices. Similarly, the expenses associated with various commodities such as aluminum, gold, steel, timber, and cement used in construction are also being reassessed.

As these evaluations progress, inflation in the United States is already significantly decreasing. In June, the increase in consumer prices was only 3%, which is a third of what it was a year ago. The inflation rate was even higher, over 9%, which was the highest in the past forty years.

Now China's increasing decline arrives to assist Powell in covering up previous errors. With the decrease in demand in the world's top trading nation and second-largest economy, the Fed no longer feels compelled to raise interest rates until the end of the year.

Admittedly, the current leadership at the Federal Reserve under Powell appears to have had more good fortune than accurate judgment. Ever since assuming the role as Fed chairman in February 2018, Powell has made two significant errors.

Initially, by yielding to pressure and implementing unnecessary interest rate reductions in 2019, despite being attacked by the former President Donald Trump through social media and interviews, the Federal Reserve jeopardized its team's authority. Subsequently, in 2021, the Fed failed to promptly respond to evident indications of inflation intensifying, resulting in their frantic attempts to catch up, which unfortunately led to the demise of one or two banks.

However, we find ourselves in a situation where the Powell Federal Reserve is currently enjoying the benefits of a decrease in inflation and a struggling Chinese economy that is providing some much-needed support at the right moment. Of course, it is not solely due to China. According to Zhichun Huang from Capital Economics, the decrease in producer costs can also be partially attributed to the fact that global commodity prices were skyrocketing a year ago due to Russia's invasion of Ukraine, making the comparison base higher.

However, China is evidently exerting a considerable impact on the ability to control prices worldwide. More and more economists express concerns about the emergence of deflation in China, a situation that Japan has struggled immensely to overcome.

China's President Xi Jinping could potentially risk losing the advancements made in recent times towards reducing the country's debt burden.

According to economist Carlos Casanova at Union Bancaire Privée, there is a significant decrease in prices across various sectors. Out of the eight main categories, six have experienced deflation. These sectors include automotive fuels, long-lasting consumer goods, and food. Casanova highlights that the pressure of deflation primarily affects prices in the early stages of production.

Even though prices for consumers are not changing much or are slightly decreasing, prices for producers fell by 5.4% in June compared to the previous year. Casanova adds that these recent inflation figures indicate a noticeable decrease in China's internal demand.

China is facing challenges from both internal and external forces. On the domestic front, retail sales are consistently underwhelming, while the bond market, valued at an immense $20 trillion, is causing concern among traders who are speculating about potential defaults within the real estate sector.

Outwardly, international deliveries experienced a larger-than-anticipated decline of 12.4% in June compared to the previous year. This suggests that if President Xi Jinping had intended to rely on exporting to achieve a 5% GDP growth for China, an alternate strategy needs to be considered.

This is not a favorable situation for the United States in general. While it may appear beneficial that China is assisting Powell in controlling worldwide inflation, a decrease in demand from China is the opposite of what governments from Washington to Berlin to Tokyo had anticipated for 2023. Additionally, this is not advantageous for economies spanning from South Korea to Southeast Asia to India.

It is possible for circumstances to alter. Should Xi and Premier Li Qiang decide to accelerate China's stimulus-industrial complex, as the country has frequently done in the past decade and a half, there could be a rapid change in global price predictions. The scenario would be similar if the People's Bank of China chooses to reopen the monetary floodgates.

Nevertheless, it is likely that China will exercise caution in this situation. President Xi would risk undoing all the progress made in recent years to reduce the economy's debt burden. By allowing more liquidity into the system, the Chinese government might inadvertently promote the very same irresponsible practices it has been working to eliminate. Moreover, any further depreciation of the yuan could pose difficulties for real estate developers who have borrowed in US dollars, leading to an elevated likelihood of default.

Moreover, Xi is highly averse to China encountering a situation where it is once again included in the U.S. Treasury Department's roster of "currency manipulators." This is particularly crucial in light of the upcoming 2024 election, which holds the potential for Trump securing the Republican nomination once more.

Trump and his dedicated followers in Congress are eager to engage in a confrontation with China. In reality, targeting China after the Covid-19 pandemic might be the sole matter of concurrence between Republicans and President Joe Biden's Democrats.

In the meantime, it is probable that China will keep reducing the inflationary heat for the Powell's administration in Washington. At the moment, that's the situation.