uploads/2016/01/FF-rate41.jpg

Deflationary Pressures Rising, Is China Worsening the Situation?

By

Updated

The key issue is deflation

Soros identifies the key issue facing the global (ACWI) (VEU) economy currently as deflation. Lower commodity prices, the currency war, and a slowdown in industrial production in major world economies are leading the world economy into a state where deflationary pressures are rising. China’s economic slowdown is impacting all of its major trading partners along with its domestic economy. The United States, Hong Kong, and Japan are the three largest trading partners of China.

So, with China (YINN) (FXI) exporting deflation into global markets, 2016 may be a “difficult” year for the world economy. Producer prices in China fell 5.9% on a year-over-year basis for five months in a row. The yuan also fell 5% over the last six months.

Article continues below advertisement

What can central bankers do?

Historically, central bankers have lowered interest rates to boost economic activity and to avert deflationary situations. However, with most of the developed world at zero-bound already, what can central bankers do?

According to George Soros, quantitative easing has worked well in the past. Ben Bernanke got it right in the 1930s and saved the world from the Great Depression. He does, at the same time, recognize the fact that “quantitative easing works, but it has a diminishing return.”

Would the Fed cut rates?

Effective December 17, 2015, the Federal Reserve hiked interest rates in the United States by 25 basis points. Soros believes that the Fed was “one year too late” to raise interest rates, doing it at a time when the US economy (SPXL) was already slowing down. Households were cutting down spending to save for the future as they thought things would get even cheaper the following year.

For 2016, Soros would be “surprised” if the Fed went for another rate hike. This is against the background that many Fed officials have hinted at four rate hikes this year. The markets expect two. On the contrary, we could see the Fed correcting the mistake of hiking interest rates in December 2015 by a rate cut this year. It would, however, not amount to being a monetary stimulus. Rather, it would just be correcting the mistake of hiking rates when the US economy (SPY) was already slowing as per Soros.

Advertisement

More From Market Realist