What China's deflation could mean for the global economy

China saw consumer and producer prices both decline in July. The world's second-largest economy is struggling against falling domestic demand. Ben Emons, NewEdge Wealth Senior Portfolio Manager and Head of Fixed Income & Macro, explains that China's deflation was "domestically generated," attributing it to pork prices and transportation costs. Emons notes "the impact that it will have on other economies is limited."

Emons goes on to outline the importance of China's post-pandemic recovery: "We can conclude that China reopening last year... probably has affected the Europe and U.S. economy staying out of this presumptive recession."

Video transcript

JULIE HYMAN: Well, China saw both consumer and producer prices fall in July. It's the latest red flag as the world's second-largest economy struggles against slumping domestic demand. Could cheaper China prices help the US and other world economies in their fight against inflation, or is China's deflation in for a reversal in the months ahead? With more, we're joined now by Ben Emons, who is head of fixed income and macro and senior portfolio manager at New Age Wealth.

This is something I have been struggling to understand, Ben, in full transparency. You know, how much should we wait the deflation that is happening in China?

BEN EMONS: If you go pre-crisis or even pre-financial crisis, it mattered a lot because China was producing all these really cheap goods that we imported, and that put pressure on our wholesale prices and consumer prices. But that's somewhat reversed now, even pre-pandemic, but mostly after the pandemic. So we have shifted away the supply chain to an extent. We're not-- well, we're importing but not as much anymore than we used to. And so this deflation that you're seeing today really driven by pork prices and transportation costs, that's most of it is just very domestically generated.

And I drilled in the pork price dynamic of China this morning, and I noticed that actually the government is taking some action there to try to tighten up pork supplies. So I think this deflation that you're seeing in CPI is probably mild, may stay somewhat there but reverse. And I think, therefore, the impact that it will have on other economies is limited.

JULIE HYMAN: Yeah, we're showing your pork price chart right there. I just had to highlight it because I love that one. I think it's very interesting what you're talking about with them trying to bring those prices down.

BRAD SMITH: Yeah, and we saw it in your note this morning, too, even as you were laying it out there a moment ago. You also noted as well that there was a second batch of central pork Reserve collections to stabilize prices that that's coming about. But you also mentioned in the note that the entire world doesn't revolve around Chinese pork purchases. So where else should we be keeping a close eye on, especially within the second largest economy right now, to really monitor where those signs of weakness are persisting or where, on the other side, for companies that are looking for any kind of sine of strength within that economy, where would you be keeping an eye on?

BEN EMONS: Yeah, you look first at foreign direct investments because that's, I think, key. So China has been really opening that gateway up again. But we know how they operate. They don't let everything come in at the same time, and they restrain capital to an extent from being exported out again once you have invested there. But I think that's a key part because you get the opportunity to invest in China. It is the biggest consumer market.

So as much as the pandemic has an after-effect, which is a study out that there's long COVID in China that's actually depressing to an extent consumer demand, at the end of the day, I think a lot of US and other companies will be willing to expand their operations there if they are allowed to. Now we do from the administration the other day. They put a specifically on semiconductors and new policy out that they want to restrain that. But I think if you otherwise think of Tesla or Apple or any of the GEs or other companies, China opening up its borders that's the big deal. I think that's where we want to watch.

JULIE HYMAN: Yeah, and we're also-- there's some reporting this morning some new reporting that there could be a curb from the US on certain types of venture capital and private equity investments in China as well. So I am curious. Yes, there's a lot of US companies who do a lot of business in China. But by and large, the US equity market, writ large, seems less concerned about the China slowdown overall. Is that the correct reaction? Is that-- are US investors sort of paying less attention to China at their peril?

BEN EMONS: So we came into the year. There was a lot of hope about this is the China reopening, so it's going to have a big macro story. In my view, it's still there. Like it's actually just slower reopening, slower effect, and that's maybe where the decoupling has taken place over the last number of months as the AI narrative really hyped up in markets. And people don't look at China so much in that AI context just yet even though they're are huge competitor, as we know, which is more focused here on domestic companies repositioning itself for the AI hype and is spending there and our domestic economy is just being thriving on that we had a moderation of to some extent inflation that's boosted real incomes.

So I think that is really where that decoupling between US markets and China markets is for now. So that leads you to the point of that, let's say, this reopening actually becomes a bit more surprising in the second half of the first quarter of next year. I think that we can conclude that China reopening last year in the fall or starting that probably has affected Europe and the US economy staying out of this presumptive recession because, let's face it, the trade between US and China is huge, as well as Europe. I think that has kept the situation sort of together.

But the financial markets have judged like, well, this is a slow-motion process, so let's focus on other things. I think that's why you see the decoupling.

JULIE HYMAN: So, in other words-- sorry, just to follow on that. So you think that when we do get more and more to the conclusion of that reopening process, it could provide some further upside?

BEN EMONS: I think it is. And I think that, as I said, the reopening on one hand of foreign direct investment into China, that would affect the stock market here obviously because we know this is a huge area where you can generate significant sales. Simple statistic I know from Apple is that I think they generate over $300 billion in sales in China. So if that can boost that which sales numbers have been sagging, that would be an impact on our markets given Apple's weight in the market.

On the other hand, it's also about China's own reopening in terms of outward like, as in they have looked at investments outward. There was a policy statement out the other day of trying to put more money into outward investments, which I think means investing in other real estate or property or companies. On the other hand, there's also this tourism wave that's sort of my own personal view. It's interesting how Vietnam has had a record inflow of Chinese tourism just coming through now. That's the latest statistic.

We haven't seen China tourism pick up so much just yet. I think that's another sort of, let's say, reopening tale that we're going to deal with coming from China.

BRAD SMITH: And so we've been in such a kind of deglobalized environment for the past few years now as we think about the ties and some of those severed ties between US and China on the trade front that has caused officials to have to come back to the table and try to get new deals done. But in the interim period, now you've got the reopening. Can a reopening in China drive reglobalization in the next year, two years? And what does that look like for people who are waking up this morning hearing us talk about this in the A block of this show and trying to figure out what that means for their portfolio?

BEN EMONS: Yeah. And the reglobalization would be fantastic, but I think it's a bit of a difficult reality because just listening to the rhetoric coming out of the campaigns now. Former President Trump wants to raise even more tariffs on China if he gets into office is one example and the current administration has maintained his policy. That's been actually very much of a pillar of the quote-unquote "decouplization" or "decoupling" of between US and China in terms of trade. And that is actually, I think, a key, let's say, geopolitical or political policy towards in order to see this reglobalization really take place.

On the other hand, look, trade is trade, so companies want to trade with China. And as long as there's not as much as a restriction on that, then it will flow as China tries to further reopen its economy. So I think you will see some effect coming through in a number of quarters from an improvement of trade between China, US, and Europe just from a flow perspective. But long term, if the tariffs stay in place or it becomes even more political, as we're hearing, then I'm not sure if the reglobalization is so easy to achieve.