China’s economy falls into deflation

This is an audio transcript of the FT News Briefing podcast episode: ‘China’s economy falls into deflation’

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Sonja Hutson
Good morning from the Financial Times. Today is Thursday, August 10th, and this is your FT News Briefing.

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Disney reported disappointing second-quarter earnings yesterday. And prices in China are decreasing. Plus, more and more countries in Europe are instituting windfall taxes on banks. I’m Sonja Hutson, in for Marc Filippino, and here’s the news you need to start your day.

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Disney’s revenue fell short during the second quarter of this year. It was $100mn less than what Wall Street analysts expected. That’s because of declines in the company’s TV and movie businesses. But Disney did offer some optimism. It said its plan to slash costs by $5.5bn was ahead of schedule, and it cut losses in its streaming unit. Disney shares jumped in after-hours trading.

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Data out of China has confirmed what a lot of people had been anticipating — that the country’s economy has slipped into deflation, which means prices are actually dropping. On Wednesday, the government announced its consumer price index was down 0.3 per cent. The FT’s Shanghai correspondent Tom Hale explains why.

Thomas Hale
First of all, under the pandemic, a lot of consumption shifted towards goods. This was a huge source of support for the Chinese economy. Its exports really boomed during those pandemic years, and from late last year, economists have been expecting that in 2023 those trade figures would weaken, and they have done and so that’s been the first problem. The second problem is that there’s a liquidity crisis in China’s real estate sector, which accounts for between a quarter and a third overall of its economic activity. And I think the third, slightly more mysterious problem, is the question of what a very dramatic three-year zero-Covid policy, what effects that has had on the mentality and the psychology of the Chinese consumer. It certainly looks like animal spirits have not quite returned to the Chinese economy despite this reopening at the start of the year.

Sonja Hutson
Tom says deflation could lead to bigger problems in the economy.

Thomas Hale
So I think, first of all, there’s the risk of a deflationary spiral taking hold where price just seems to be falling and consumers defer their consumption in anticipation of a fall in prices in the future. There’s also the risk of the real burden of debt increasing in an economy, if the price level is falling but the debts that were issued in the past remain at the old higher price level. So those two things would be major concerns. But I should mention that quite a lot of economists do not expect this deflationary period to last for a long time. There are signs of higher consumption of services, for example. So there are reasons to believe that the country won’t be locked in a deflationary environment for too long.

Sonja Hutson
That’s the FT’s Shanghai correspondent Tom Hale.

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President Joe Biden is banning US tech investment in China. He announced the move yesterday. The idea is to slow down sectors like AI and quantum computing that could help the Chinese military and intelligence services. The ban will mostly apply to private equity and venture capital firms. It’s set to go into effect next year. This is the latest move by the Biden administration to curb Chinese access to advanced technology. Last year, it introduced export controls that make it harder for Chinese groups to manufacture semiconductors.

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European banks have been making a ton of money recently. That’s because high interest rates mean they can charge more for loans. Some governments say the banks should be passing on the benefits of high interest rates by paying depositors more. And because they’re not, these countries are now imposing taxes on the banks’ massive profits. This week, Italy became the latest one to do so. But the rollout didn’t exactly go smoothly. I’m joined now by the FT’s European banking correspondent Owen Walker. Hi, Owen.

Owen Walker
Hey, how’s it going?

Sonja Hutson
It’s good, thanks. So how did this windfall tax in Italy come about?

Owen Walker
Well, it’s quite strange, really. I mean, it’s the middle of August, people on holiday, people away. And then on Monday night, buried in a whole load of other announcements, the Italian government said they’d be hitting banks with a windfall tax, which by some projections initially would have cost up to €4.5bn. And then it wasn’t until the afternoon on Tuesday that they actually came out with a policy document that analysts could actually look over and try to figure out how it would work. There was a big backlash. Shareholders sold off lots of shares in Italian banks. I think they lost about €10bn worth of market value throughout the day. And then by the evening, the Italian government seemed to backtrack and say there’ll be a cap on the amount they’d raise through this windfall tax so it wouldn’t hit the banks quite as badly.

Sonja Hutson
So Owen, countries like Spain and Hungary have recently pushed these taxes on to their banks. But Italy is the biggest European banking market to do this. Do you think it’s gonna be the last?

Owen Walker
I think there’s three main factors you need to look at when assessing whether a country is gonna introduce these sorts of measures. So one is a government with a populist flavour and the second is how quickly interest rates have risen in those countries. And so in Czech Republic and Hungary, they’re outside the euro, so their own central banks have been rising interest rates at a faster clip than the ECB. And then a third factor I think needs to be considered is how much of the benefits of rising interest rates banks would pass on to their customers. So as central bank interest rates rise, it’s to the degree to which banks increase the rates they offer on deposits. Now, places like Spain and Italy, the banks have really retained a lot of the benefits of rising interest rates. They haven’t been passing those on in the way that banks in the UK, for example, have been passing on a greater share.

Sonja Hutson
Does this backtrack by Italy’s government matter? Is it gonna cause other countries to be thinking “Hmm, maybe we better rethink whether or not we’re gonna institute some kind of windfall tax”?

Owen Walker
I think what the backtracking from Italy’s government, I think what it shows is that these measures were drawn up in haste and perhaps weren’t fully thought through. Now, I think other governments, if they are planning such a move, will probably be looking to spend a little bit more time on, firstly, drawing up the policies so they know exactly what impact it’s gonna be. Secondly, having a clear communications strategy. So that may be a warning to banks in advance. I don’t think it’s gonna put off other countries from pursuing banking taxes because, you know, if they have reasons to do it, they will do it regardless of the Italian experience. What they will be doing more is focusing on getting the details right and communicating it in an effective way.

Sonja Hutson
Owen Walker is the FT’s European banking correspondent. Thanks, Owen.

Owen Walker
Thanks very much.

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Sonja Hutson
Before we go, the music industry is trying to monetise its biggest threat, artificial intelligence. The rise of generative AI has led to a surge of deepfake songs. They mimic the voices, lyrics or sound of famous artists, usually without their consent. Sources tell the FT that Google and Universal Music are in talks to license artists’ voices for AI-generated songs. The goal is to develop a tool for fans to produce the deepfake tracks legitimately and pay the copyright owners for it. But musicians would have to opt in to the service.

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You can read more on all of these stories at FT.com for free when you click the links in our show notes. This has been your daily FT News Briefing. Make sure you check back tomorrow for the latest business news.

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