A lesson that crypto winter taught folks in the cryptocurrency world is that crypto is not divorced from the wider financial world. The issues with crypto winter were raging inflation and the actions of central banks trying to control it. Specifically, the US Federal Reserve and other central banks increased interest rates. This increased the value of the dollar and drove the prices of crypto tokens (in dollars) down to a fourth of their peak value in November 2021. Worries about a recession caused by excessive rate hikes weighed on both the stock market and crypto values. Today a new issue threatens markets. It is the threat of deflation in China. Could China deflation spread to crypto as well as other world markets?
What Is Deflation?
Deflation is a decline of the prices of goods and services within an economy. It commonly happens when the money supply contracts and credit tightens. Deflation, when not dealt with, can lead to recessions. In severe cases, poorly managed deflation can lead to a depression such as the Great Depression that lasted a dozen years from the 1929 Stock Market Crash until the start of World War II. Japan experienced a “lost decade” of deflation after an economic collapse brought on by massive, hidden loans at the end of the 1990s. While the value of goods and services priced in dollars falls during deflation, the value of the dollar rises. Anyone who owes money on loans finds it more expensive to pay back their debts with now-more-expensive-dollars.
Why Is China Heading Into Deflation?
We wrote recently about the effects of China’s debts on investments. A substantial part of their economic growth over the years relied on borrowing money and paying back loans as the economy grew. Now, as the economy has leveled off, that strategy has resulted in massive governmental and private debts. The debts, just like they did in Japan years ago, are slowing down China’s economy and forcing companies to reduce their prices to remain competitive. China’s crypto ban has made all aspects of cryptocurrencies illegal in the country. Thus any effects of their deflation will be felt through effects on the global economy.
China Deflation and the World Economy
After the Financial Crisis in 2008 and 2009 it was China that got the world economy going again. This did not happen with Covid as the country continued with lockdowns long past when other nations opened up. When they did stop the lockdowns many expected China economy to surge and, again, stimulate global business. It did not happen because of their debt crisis and an increasing tendency of other nations to bring manufacturing either back home or to countries deemed to be friendlier than China! The point is that China will not rescue the world economy from the effects of higher interest, rates everywhere. In fact, it may make the global economy worse by purchasing fewer raw materials from developing nations and less advanced tech from the West.
How Could China Deflation Affect Crypto?
The deflation in China is likely to lead to a recession there and to exacerbate recessionary pressures across the world. Central banks will be less likely to raise interest rates and probably lower them. This will help raise crypto prices against the dollar and other currencies. Depending on the severity of a recession outside of China stocks will fall to some degree. Because Bitcoin and the rest tend to track up and down with the Nasdaq market this may tend to drive crypto down. CoinDesk has a good article about the end of the global liquidity tightening cycle that relates to this issue.
Could China Deflation Spread to Crypto? – SlideShare Version
