Deflation could hurt the global economy, accelerate manufacturing declines

 In Newsletter, Newsletter Pro

Issue No. 123


Assets Covered: Consumer Price Index, Industrial Production

Countries Covered: China, Germany, United States


Last week’s news of new jobless claims hitting 17 million in the US has been a stark reminder of the times. At the same time, China’s “official” unemployment report states 5m newly unemployed, but there is suspicion this could be 5-10 times higher. Our recent Twitter poll shows an expectation that China’s unemployment rolls have reached at least 20 million and possibly more than 50 million. It’s not just bad. It’s dire.


China unemployment survey


As workers have stopped working and companies have stopped selling, deflation has been one of our biggest worries. In very oversimplified way, deflation is a demand problem. Less money chases the same (or more) goods. Because there is less ability to pay, buyers can’t pay the same prices they paid in the past.


With economic shocks, it’s normal for companies and individuals to initially tighten purse strings. That’s a prudent measure, so the fall in some prices doesn’t necessarily mean that deflation has taken root. Crude oil (WTI Crude), for example, has taken a huge hit, falling from above $50 just six weeks ago to the low-$20s this week, despite a grand OPEC+ agreement over the weekend. This could be (and we believe it is) the start of a deflationary cycle, but a single commodity price falling isn’t necessarily deflationary.


In the US, the average price of a gallon of gasoline was nearly $2.50 just six weeks ago. Today it’s $1.82. Falling prices may seem good in the short term to consumers who are cash strapped – and we all need relief at the moment – but if we are truly dipping into deflationary territory, the worries far outweigh the benefits.


Given the sharp decline in employment, it’s possible that consumers and companies lose the ability to pay “normal” prices for goods. This may trigger a cycle of price cuts, further job cuts, wage cuts and so on until the market finds new, lower price, employment and wage levels.


Gasoline (part of transport in a country’s Consumer Price Index) is only one item that consumers buy. Transport, food, housing, clothing, etc all make up Consumer Price Index (CPI) baskets, which vary by country. We see prices muted overall in advanced economies, generally falling from Q4 2019. Our most dire expectation is that China’s CPI falls negative in Q2 and stays negative for a prolonged period as energy, housing, and other pricing levels fall in the wake of corona/Covid-19 and as the export-dependent overproduction by China’s factories is painfully reconciled into market balance at lower price levels.


Consumer Price Index Forecast US Germany China 2020

Consumer Price Index: China, Germany and United States forecast through 2020
This chart was generated using CI Futures. Book a demo to see it in action.


This could lead to a fall in manufacturing, given the overcapacity that usually accompanies deflation. As a result, our artificial intelligence platform expects Industrial Production to fall in Germany, which was already negative in 2019. Employment, wages and demographics also play a large part in Europe’s manufacturing decline.


2020 Industrial Production Forecast China US Germany

Industrial Production: China, Germany, United States forecast through 2020
This chart was generated using CI Futures. Book a demo to see it in action.


China’s story – again – could be worrisome. We expect China’s Industrial Production to fall around 6% this year. That could be catastrophic to China’s economy and to Asia more broadly.


The global economy already looks rough and deflation would only hurt. While we pride ourselves on the quality of our forecast, let’s hope we’re wrong this time.

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