China's Producer Deflation Could Crush Smaller Manufacturers Around The World

China is known for exporting manufacturing products to the world. It may soon develop the reputation of exporting something else, producer deflation--the falling of wholesale prices.

That's according to a string of data showing an accelerated decline in the Producer Price Index (PPI), a measure of what China's factories charge to their clients.

In June 2023, for instance, China's PPI dropped at an annual rate of 5.4%, following a 4.6% fall in May and above market forecasts of a 5.0% decline.

The June decline was the ninth consecutive month of PPI drop, confirming that China's economy is in a deflationary spiral at the wholesale level.

That isn't the first time the world's second-largest economy has been on a deflationary path. It happened in the 1990s, in 2008-9, and more recently, in 2016-20.

China's wholesale deflation results from old and new demand and supply pressures.

Demand pressures stem from a decline in the country's exports.

Thanks to competition from emerging markets like Vietnam and growing tensions between Beijing and its Western trade partners, most notably the U.S.

Exports from China dropped at an annual rate of 12.4% to $285.32 billion in June 2023, following a 7.5% fall in May. It's the steepest drop since February 2020, led by declines in aluminum products (-18.9%), steel products (-0.6%), and grains (-36.4%).

"The confrontation between China and the United States has lowered China's aggregate demand as China's export, a significant portion of China's GDP, declined," Dr. Tenpao Lee, professor emeritus of economics at Niagara University, told International Business Times.

Then there's a slow-down in the domestic demand as evidenced by recent government reports, which show a lower-than-expected GDP growth.

For the second quarter of 2023, the Chinese GDP grew at an annual rate of 6.3%, up from a 4.5% growth in the first quarter but well below market estimates of 7.3%. And numbers could look far worse if it wasn't for last year's weak numbers due to lockdowns in major cities.

Supply pressures stem from China's old problem of excess factory capacity due to the building of factories that practically duplicate each other. These factories churn out similar products and engage in a price war.

"The issue of excess factory capacity and price wars within the country adds another layer to the deflationary challenge," Justin Albertynas, CEO of Ratepunk, told IBT.

China's deflation will soon be exported to the rest of the world, as the country is the world's largest factory, making it a price-maker.

That's both a good thing and a bad thing for China's trade partners. It's a good thing because it will help central banks worldwide fight inflation.

It's a bad thing because China's lower manufacturing prices, state-of-the-art logistics, and transportation costs will put competitive pressure on producers of similar products.

Already, some European manufacturers are feeling the pressure. Thessaloniki, Greece-based Dion SA, the largest manufacturer of recycled plastics, is one of them.

"China is turning into a formidable competitor in the plastics materials," Sakis Dionisopoulos, President of the company, told IBT. "They have the scale, the low electricity prices, the logistics, and they face low transportation costs thanks to the falling oil prices. They ship massive quantities of products to Malta and then distribute them throughout Europe, including the port of Volos in Greece."

That could unleash another round of tensions between Beijing and its European trade partners.

"It is clear that China's current deflationary spiral presents a mixed bag of opportunities and challenges," added Justin Albertynas. "As these deflationary effects ripple beyond China's borders, it becomes crucial for international stakeholders to collaborate and navigate this evolving economic landscape with a coordinated approach."