Investing With a Deflationary China

While the US is still battling inflation, China is slipping into deflation. The usual way for a government to fight deflation is to loosen credit, drop interest rates, and spend money on domestic infrastructure projects. Unfortunately, China’s debts are huge, which limits how much farther in debt central and local governments in China can go. There is a very real risk that China will slip into a prolonged period of deflation similar to what happened with Japan at the end of the 1980s. Investing with a deflationary China will require new strategies for investors accustomed to a steadily growing Chinese economy.

What is Deflation in China All About?

Bloomberg reports that China is on the brink of deflation. What this means is that people are becoming more and more careful with their purchases. Stores and manufacturers are lowering prices in order to keep selling. The degree to which this is a consumer issue became clear when people started eating less pork which is a staple of diets in China. Prices went down. When this sort of thing happens, people often put off buying things because they believe that prices will continue to fall. This creates a downward deflationary spiral. This is the domestic aspect of deflation in China.

Anywhere But China Offshoring and Chinese Deflation

China has become increasingly aggressive during the “reign” of their current leader, Xi Jinping. They are ramping up their military and pouring money into advanced technologies in a race to pass the US and EU as centers of technological excellence. They are also building a substantial nuclear arsenal and missile silos for launching ICBMs. They have made it clear that they want to bring Taiwan back under the governance of central Chinese governance. All of this has come as the Covid-19 pandemic and interminable lockdowns afterward caused severe disruption of global supply chains. Countries far and wide have come to realize the perils of relying on China for everything from surgical masks and Band-Aids to aspirin, solar panels, and lithium batteries for electric vehicles. The “reshoring” or “onshoring” that has taken place as companies relocate anywhere but in China is starting to leave Chinese factories without work. We expect that this movement will only accelerate.

Who Gets Hurt If China Goes Into a Period of Deflation?

Clearly businesses in China will suffer as local Chinese and foreigners buy less. So will US and European companies that do business in China. The companies with the largest portion of their income coming from China will be hurt the worst. Here is a list, courtesy of the Observer, of companies with the most to lose as business in China shrinks. The percentage is how much of the company’s business comes from China.

Wynn ResortsCasino70%
Las Vegas SandsCasino63%
Texas InstrumentsSemiconductor55%
IPG PhotonicsFiber lasers42%
Western DigitalData shortage40%

Large companies with much to lose as business in China suffers also include Apple (20%), Tesla (21%), and General Motors (10%).

A third of Australia’s foreign trade is with China. A reduction in manufacturing associated with deflation will hurt business in Australia. 31% of Brazil’s exports go to China which means their economy will also suffer as China slows down due to deflation. Around the globe most countries have a substantial portion of their foreign trade with China. What this means is that a slowdown in China due to deflation will spread across the world. On one hand, if China reduces its prices to keep customers, it will serve to reduce inflation elsewhere. On the other hand, when China spends less on imported raw materials or tech items it will slow the global economy.

Investing by simply buying shares of an ETF that tracks the S&P 500 worked well for much of the time after the Financial Crisis. But, if the entire global economy slows as a result of deflation in China, targeted investments in areas like artificial intelligence may become more profitable and therefore more popular.

Deflation Makes Cash King

When the price of everything goes down due to inflation that effectively makes cash more valuable. Holding onto cash was a losing proposition for years as bonds stagnated and stocks soared. The reverse just might become the case as cash becomes more valuable even without high interest rates.

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