A VERY DIFFERENT DESTINY
However, there are some marked differences between Japan in the late 80s and where China, for example, finds itself today. Not least, China is still developing. This means it still has a fair degree of policy flexibility open to the authorities to tackle the deflationary threat.
“What could Chinese policymakers do if confronted by a sudden bout of deflation?” asks RBC Global Asset Management chief economist, Eric Lascelles. “Practically anything. They have an unprecedented amount of control over their country’s economic levers. A short list of options would include cutting interest rates, printing money or depreciating the renminbi. But the most important tactic would be grappling with the country’s debt excesses should they ever come home to roost, as opposed to allowing any problems to fester.”
Fidelity’s Stupnytska says that, because China’s economy is not as advanced as Japan’s, the ‘catch-up’ to the developed country income levels creates some room for manoeuvre.
As such, she says: “With appropriate policies in place, China can avoid the ‘lost decade’ experience. Chinese policymakers are aware of the dangers and actively pursuing a reform agenda.”
China’s relative lack of development is a key differentiator from Japan. The lower amount of capital per unit of labour means the return on capital is higher, which means higher growth and, by extension, inflation.
That said, China has seen a marked slowdown this year – from 2.3% in March to around 1.3% for the latest figures. However, the reasons for this could sit in complete contrast to those of Japan.
According to Jan Dehn, head of research at Ashmore, China is slowing precisely because it has been able to push through massive structural reform. “China is experiencing a reform-driven slowdown,” he says. “This is the primary difference with Japan, whose problems are mainly due to lack of reform.”
A period of extraordinary economic reform, such as China’s ongoing rebalancing away from investment and exports towards consumption, naturally creates uncertainty. That, in turn, increases the hurdle rates for investment and drives up domestic savings rates.
However, China’s reform programme has the scope to massively increase consumption. By liberalising prices, opening the capital account, building yield curves where none previously existed, improving the rule of law (including contract law), allowing markets a greater role to direct the flow of capital and providing an efficient social benefit system, Chinese consumers will be offered a greater degree of security. And if they feel more secure in their future, they may not feel included to save to the same degree.
IMF figures show the gross national savings rate for China in 2015 was 50% (compared to 25% in Japan), which provides what Dehn describes as “enormous room” to increase consumption and drive up consumer prices.
Aon Hewitt’s head of asset allocation, Tapan Datta, believes China should manage deflation though increasing aggregate demand rather than following Japan’s monetary policy route. “It is difficult to argue that China could do much more,” he says.
It is essential, however, that China doesn’t go back to credit-fuelled demand and focuses instead on areas that support consumption, such as the housing and mortgage markets, developing social infrastructure and transport.
Continuing to push through reform would, Dehn believes, set China up to prevail in the long term and should “pay off handsomely”.
“Once developed market QE has run its course,” he says, “those countries will need to deflate their currencies.
China’s currency will then go up, instead of down, so it needs to use this time to wean itself of its export-led economy and increase consumption. Everything China is doing makes sense from a long-term perspective.”
