Is China exporting deflation?

There is little doubt that China is redirecting credit from the property sector towards industry, including to sectors the leadership regards as strategic. The production of the so-called ‘New Three’ for example – electric vehicles (EVs), batteries and solar cells – is up between 80% and 800% since 2019.

It is equally true that the supply push is leading to overcapacity and deflationary pressures. China’s GDP deflator, producer prices and export prices are falling year-on-year and US imports from China have cheapened more than imports from the rest of the world. In response, the US this week announced tariffs ranging from 25-100% on the ‘New Three’ and a couple of other Chinese products.

So, is China really exporting deflation and should we start to account for this in our investment decisions? At the macro level, we don’t think so, but at sector level there may be more profound opportunities and challenges. Much of the macro data at least is telling a different story.

For starters, the ‘New Three’ have grown from low levels and are still relatively small. We can combine data on production volumes with price data to derive the sectors’ GDP share – a modest 2.1%. They are 1.2% of US GDP – never mind that Chinese sales to the US are minuscule.

Second, Chinese export volumes have not been that strong. They grew 4½% in 2023 less than the Chinese economy and while they were up 13% year-on-year in Q1, they fell back to zero in April. Also, export prices have been rising since October, improving from -10% year-on-year to -2½%.

If China were flooding the world with cheap manufacturing goods, we should see a rise in the country’s current account balance. However, China’s surplus has been falling since the second half of 2022 and is modest at 1.2% of GDP. The trade deficits that the US and Europe customarily run with China have shrunk by 1 percentage point of GDP recently and stand at an unremarkable 1% and 1.6%, respectively.

Finally, developed economies are importing less not more manufacturing goods from China. This is true in aggregate, but also for each one of the large, developed economies we look at here – the US, Europe, UK and Japan.

To a large extend this reflects a reversal of the unusual COVID trade pattern, but it is hardly the Chinese deluge that some news reports suggest. Also, in aggregate China’s share in advanced economy manufacturing imports has been declining since 2010.

China is no longer the economy that floods the world with cheap goods, but its targeted approach to key sectors can significantly alter the dynamics of an industry and potentially threaten established Western players. We have seen that with solar panels already, could the auto sector be next?