The Chinese economy remains trapped in deflation. Falling prices reflect demographic shifts as well as politically induced overcapacity in real estate and industry. The export sector continues to act as a pressure valve, though it is increasingly facing international political pressure.

China’s economic ascent is visible in its impressive infrastructure, massive urban growth, and technological capabilities.

Since last year, statistics show that the country has become a net capital exporter and has technologically surpassed Germany’s long-dominant industrial sectors. Yet, above all this shine hangs the Damoclean sword of an ongoing deflationary phase.

The Chinese economy is now entering its third consecutive year in a falling-price environment. In the final quarter of last year, the GDP deflator fell another 0.7 percent, according to Bloomberg.

The deflator measures the average price change of all domestically produced goods and services, comparing nominal to real GDP — a more precise measure of inflation than arbitrary consumer price indices, which often fail to reflect actual price changes.

Consumers postpone major purchases, expecting prices to fall further. Domestic demand in China remains muted.

As a result, corporate profits come under pressure, reflected in the stock market: roughly a quarter of publicly traded companies reported losses in the second half of last year. Price wars in competitive sectors like automotive and especially real estate are squeezing margins and curbing investment.

This affects the labor market, reinforcing relatively high unemployment among young workers — a problem for Beijing’s Communist leadership, whose central promise is: you forgo political participation, we ensure steadily rising prosperity.

Factory and producer prices, measured by the PPI, have fallen for 40 consecutive months. The economy slowly unwinds the overcapacities created by political interventions to stabilize growth, especially after the 2008/2009 global financial crisis.

Stimulus Measures and Stabilization Policies

The relatively swift global economic recovery after the shock of 15 years ago was largely due to Beijing’s decision to place the real estate sector at the heart of domestic stabilization.

The creation of roughly 65 million vacant housing units — about 21 percent of China’s total real estate stock — not only stabilized the domestic economy in the short term.

It also significantly boosted global demand for raw materials and energy. Traditional commodity exporters in South America and the Middle East benefited, receiving a welcome lifeline in the face of looming debt crises.

Since 2005, interest rate cuts and expanded bank credit have further fueled bubbles in the real estate market. These continue to trigger recurring sector bankruptcies and falling property prices.

Massive mortgage defaults strain private banks’ balance sheets, repeatedly drawing government attention and prompting new stabilization measures.

The Fiat Money Problem

Falling prices in a competitive economy are essentially efficiency gains benefiting consumers. That is how it should be.

But in a fiat credit money system, where money is created virtually out of nothing through new lending, falling prices act like a deadly blow to the debt machine. Loans must be repaid with interest; in deflation, both money supply and nominal income shrink.

Debtors literally get squeezed, as the revenue intended to service interest falls. The economy slides into a balance-sheet crisis with declining cash flow.

At this moment, the political central planner steps in with artificially generated government demand — as we currently see in Germany via the “special fund.” This creates ever-new credit bubbles. Economic inefficiencies become entrenched; capital and resources are misallocated.

In short: economic productivity loses momentum, and the societal prosperity expected from technological progress is literally burned on the balance sheet.

Recurring credit bubbles also hit savers. Those holding wealth purely in cash or money-market instruments see purchasing power melt like an ice cube under the sun due to continuous credit expansion.

Export Sector as Pressure Valve

Chinese policy has clearly maneuvered itself into a classic fiat-money trap. Authorities must simultaneously release air from numerous credit bubbles — such as in real estate — while using targeted interventions and precise credit management to prevent sectoral collapse, without triggering a domestic currency confidence crisis. Once an economy enters this spiral of intervention, there is virtually no way out without risking major shocks.

As a last resort, Beijing has long relied on its strong export sector. To support this massive production engine, China traditionally provides VAT rebates of up to 13 percent in industries such as solar panels and automobiles.

There are also extensive domestic incentives: low-interest loans from state banks, energy subsidies, and research grants totaling hundreds of billions of US dollars annually. This continues to drive overcapacity in steel, e-mobility, and chemical production.

With these policies, Beijing effectively crushes international competitors, many of whom lack comparable fiscal resources or the ability to set wages and salaries by decree. The effects are obvious.

China’s trade surplus exceeded the symbolic $1 trillion mark last year, reaching $1.189 trillion — about one percent of global GDP.

The U.S. response, using massive tariffs to push back China’s export engine, also impacts other regions, such as the European single market. Europe has effectively become a secondary dumping ground for China, causing tensions between Brussels and Beijing. The dispute over China’s export controls on rare earths — a sector where the country has global dominance — is another symptom of rising friction.

China’s domestic imbalances thus translate directly into economic-political complications in Germany, where the local auto industry is increasingly pressured by Chinese competition and domestic energy sector challenges.

It appears that trade conflicts will accompany us for the long term. In July last year, the European Parliament already enacted countermeasures, such as export restrictions on strategic goods on which China depends — e.g., solar panels or inverters.

Since October, the introduction of commodity tariffs on critical raw materials has also been under review. Penalties and exclusion of Chinese firms from strategically important procurement markets are being added to Europe’s strategic trade toolkit.

How effective this strategy will be, given Europe’s clear dependence on selected Chinese imports, remains to be seen. Whether it was wise to simultaneously engage in a long-term confrontation with the U.S. administration is, in light of Beijing’s hard line, highly questionable.

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Thomas Kolbe, born in 1978 in Neuss/ Germany, is a graduate economist. For over 25 years, he has worked as a journalist and media producer for clients from various industries and business associations. As a publicist, he focuses on economic processes and observes geopolitical events from the perspective of the capital markets. His publications follow a philosophy that focuses on the individual and their right to self-determination.