Firstly, I want to clarify a concept: “Deflation.” Deflation generally refers to the negative growth of a basket of goods and services price index over a certain period. Accompanied by this is the output level. When the output level falls away from the potential level, the combination of price and output constitutes a “recession” scenario. When the output level does not grow for a long time, causing the potential growth rate to also decline systematically (macroeconomic hysteresis effect), this combination of price and output forms the “liquidity trap” scenario. If durable goods like real estate and stock and other securities asset prices also plummet against the backdrop of negative or slow growth in the goods and services price index, the financial flow costs of the economy will systematically increase, as described by Bernanke in his work, “Essays on the Great Depression.” It becomes difficult to reduce the actual market interest rate relying solely on market forces, and the policy cost of stimulating demand will also increase. If the currency is also under devaluation pressure in the foreign exchange market, stabilizing asset prices becomes more challenging. China is indeed facing the risk of a “recession” now. The decline in retail growth is too swift, while the risk of Japan’s “liquidity trap” is still some distance away. China’s output level growth is still around 5%, far from zero. China is a super-large economy with self-sufficiency in agriculture and energy, ensuring ample monetary policy and exchange rate flexibility.
Deflation doesn’t disappear on its own. It is typically a debt-driven market failure. The evolution of deflation might lead to minor recessions. 23 high-income countries experienced 166 recessions between 1960 and 2010, as cited by Blanchard. It might also trigger more severe downturns, like the Great Depression of the 1920s and 1930s, Japan’s “Lost Decade” in the 1990s, and the global financial crisis around 2008. Academics have derived numerous economic insights from studying these recessions. One consensus is that deflation is primarily a monetary phenomenon. Governments can address it through measures like interest rate cuts, quantitative easing, and the monetization of fiscal deficits under modern monetary theory. Non-monetary socio-political issues should be supplemented with other measures. The philosophy here is to save lives first and then address the disease.
Now, let’s delve into China’s current economic issues in three parts:
1. The Origins of the Japanese Story
We need to look at Japan’s “Lost Decade,” “Lost Two Decades,” and “Lost Three Decades.” Commonly in China, Japan’s economic downturn is believed to have begun with the Plaza Accord. This populist view holds that in international competition, one cannot surrender on exchange rates or compromise in international economic negotiations. However, politics is the art of compromise. Wu Jinglian, a renowned Chinese economist, has always maintained that Japan’s economic stagnation began mainly due to strategic mistakes in domestic policies to address currency appreciation. Japan created a huge asset price bubble, not just in real estate, but also in highly liquid assets like stocks. When the bubble burst, the massive debt issue dragged down Japan’s economy.Japan’s economy’s turmoil spread deeper into society, and the nation continuously switched political leaders. This instability made it hard for the government to undertake significant structural reforms and redistribute social benefits. Japan’s stock market became a disaster zone for international investors, and the real estate market was no different. Only when Shinzō Abe brought stability to the political landscape and launched the “Three Arrows” economic reform – structural reforms, aggressive monetary policy, and bold fiscal policy – did Japan’s stock market gradually start rising in 2012, a trend that lasted until around 2017. After Abe stepped down due to health issues and was succeeded by Yoshihide Suga, he remained an active political figure in Japan. Unfortunately, Abe’s assassination was a direct result of long-standing economic stagnation and social tensions. Abe’s reforms failed to reverse the downward trend in Japan’s birthrate, a societal issue he was trying to address. The problem lay in the inherent limitations of Japan’s Liberal Democratic Party’s economic reforms.As of April 2023, Japan’s stock market has risen faster than global averages, drawing investor attention. Japan’s GDP growth exceeded expectations in the first (1.3% YoY) and second quarters (6% YoY), leading some to label this the “New Normal.” The 3.5% inflation rate hasn’t led to stagflation but instead has boosted wage growth and economic output. After Haruhiko Kuroda’s retirement and Kazushige Ueda’s appointment, discussions on relaxing the yield curve control (YCC) policy might signal that Japan won’t tolerate another asset price bubble.Many academic works discuss the Japanese story. An interesting viewpoint by Kuznets is that there are four types of countries in the world: developed countries, developing countries, Japan, and Argentina. This viewpoint highlights the uniqueness of Japan’s economic phenomenon.
The academic world has many debates and descriptions about Japan’s story. Kuznets made an interesting observation: There are four types of countries in the world – developed countries, developing countries, Japan, and Argentina. This visualized viewpoint is still discussed today, indicating the uniqueness of the Japanese economic phenomenon. Of course, the global economic development predicted by the Kuznets curve doesn’t seem to have occurred and continues to plague major economies today. The essence of Japan’s problem should be the logic discussed by this curve. Bernanke’s criticism of Japan’s monetary policy appears in works like “The Courage to Act” by Bernanke and “The Age of Turbulence” by Masaaki Shirakawa. The main focus is that “price as a monetary phenomenon should take decisive action in the face of debt and deflation”, which was also Bernanke’s approach during the 2008 global financial crisis. By this monetary measure, it was successful, with the U.S. stock market returning to pre-crisis levels around 2013. However, events such as Occupy Wall Street and Trump’s election reveal the impotence of liberalism and conservatism in the face of structural societal reforms. Japan is no different. Currently popular in China is Gu Chaoming’s theory of balance sheet recession. The crux of Gu’s theory is also about money itself. But the contradiction in his theory is how a balance sheet recession can dominate an economy for as long as thirty years, and whether monetary phenomena can determine overall societal economic relations.
The above provided a brief review of the origin of Japan’s liquidity trap, the subsequent formation of bubbles under policy systems, and the aftermath of the bubble burst, up to the prosperity of the Japanese stock market in 2023. From a historical materialism perspective, Japan, as a nation, has not fulfilled its mission of national development. This is a result of both internal and external, economic, and political factors, and cannot be simply described as Japan’s deflation. Below, we compare the similarities and differences between China and Japan.
2. China’s Story
Currently, the greatest similarity between China and Japan is that both face the historical opponent, the United States. In the China-U.S. contest, China can ensure mutual destruction with the U.S. in military, economic, and financial fields, something Japan couldn’t compare with. There’s no perfect haven for international capital; it won’t abandon either side, ensuring monetary support and smooth trade.
China is also dealing with the consequences of earlier economic bubble growth, with rapid rises in real estate prices. Unlike Japan, when real estate prices in China fell, the country’s securities asset prices didn’t experience significant bubbles. This ensures some asset price stability and represents a significant opportunity window for corporate financing. The situation now suggests that we learned from the Asian financial crisis, with strict management in enterprise and government foreign financing, manageable external debt, combined with our capital control policies. However, Japan did not have these conditions back then.
For China’s economy, the consensus now is to stabilize the declining economic growth rate and actively counter recession risks. Once output growth is stable, under the force of market dynamics, supply and demand will quickly adjust, and prices will naturally rise after the healthy derivation of money. Specific policy measures should include bold debt stripping measures, setting up special re-lending tools. Along with this, there should be a clear counter-cyclical regulation policy exit timetable to stabilize decisive market expectations. Companies should seize the historical opportunities of the green and digital economy and deeply participate in supply-side structural reforms and social reforms to expand effective domestic demand. We should leverage labor wages and price levels to stimulate all parties’ enthusiasm, effectively address ownership financing discrimination, and the private economy should also undertake the major national development tasks.
After discussing short-term monetary issues, we shift to a broader historical and social perspective. A primary difference between China and Japan is that China, led by the Communist Party, is a vast economy still at the forefront of international technological competition. China has the ability to reconcile major internal conflicts, make adjustments at a smaller cost, and avoid prolonged ideological turbulence during social reforms. China’s current ideological debate is: Does it need a loose monetary environment or a moderately tight one during profound socio-economic adjustments? This is not new; every time there’s a major reform, this debate arises, but the issue is, history doesn’t provide a single answer. China’s loose monetary policy orientations around 1995 and 2010 both came with economic fluctuations from inflation to deflation, which we seem to dislike now. Thanks to China being a vast economy, recessions recur in history. In contrast, smaller economies, after a single debt issue, are often shattered by international finance.
Japan’s liquidity trap is a product of both economic and political forces. It’s not an inevitable historical process, primarily a monetary phenomenon, and on a deeper level, socio-economic relations, with corresponding solutions. What China needs to ponder over the long term is: Why did the Soviet Communist Party lose out in its confrontation against the U.S.-led Western bloc? How does China’s philosophy of a harmonious world integrate with the reform of the international governance system? In the 1990s, with the collapse of the Soviet Union, the U.S. became the sole superpower, where any challenges wouldn’t gain full trust from international capital. In that era, a Japanese-American proposed the “End of History” theory, but history didn’t end. Instead, the Japanese economy began its “lost decade”. When the Japanese economy showed a decline in the Western system, international capital chose to leave. Its decline lacked support, making stabilization challenging. But the current international situation has fundamentally changed, with Russia, Islamic countries, emerging markets, and African nations playing vital roles on the world stage. U.S. conservatives are showing decline in domestic politics, with U.S. socio-economic relations under intense ideological currents. No one in global capital likely believes the “End of History” theory of the 1990s anymore; the China-U.S. competition is entirely different from the Japan-U.S. dynamic.
Currently, the focal point of the China-U.S. century-long contest lies in technology. China’s current recession risks do not hinder the continued advancement of technology. Technology seems to be independent of economic cyclical movements; that’s the charm of technological progress. U.S. companies like Apple and Microsoft were both founded in the 1970s, during the U.S. oil crisis. Even under stagflation, technology still made significant progress. Today’s era will be the same.
3. Conclusion
In conclusion, here’s a brief summary in three points:
1）China indeed faces the risk of “debt-domestic demand deflation.” This is an economic cycle phenomenon. Economic recessions in the history of world economic development are not uncommon, and there’s ample research to attest to that. The subtext of Japan’s deflation is a phenomenon that lasted for ten, twenty, and even thirty years. It’s not merely a simple economic cycle issue. Although deflation happens in world economic history, few examples are like Japan’s. China is a super-large economy, with self-sufficiency in agriculture and energy, ensuring ample monetary policy and exchange rate flexibility. The production growth rate remains high. The Triennial Third Plenary Session held every five years is worth looking forward to.
2）China has a great nation and civilization, striving for a unique standing among world nations. The history of human development is a brutal competition. Those civilizations that have survived to the present demonstrate resilience. China’s humiliating modern history vividly depicts its fight for survival and rejuvenation. Borrowing from Henry Kissinger’s views in “On China,” he believes figures like Li Hongzhang and the Self-Strengthening Movement took a compromising approach. They introduced various imperialist forces, preventing China from becoming a complete colony, preserving vast territories of historical inheritance, avoiding division, and retaining the identity of a rejuvenated major civilization. Even under such pressure in modern history, the Chinese nation managed to forge a path. In the 21st century, there’s even greater cultural confidence.
3）Current capitalism and socialism both face the heavy responsibility of structural reform, seeking ways to address income distribution disparities. Today’s capitalism is no longer a unified entity under the Washington Consensus. Its internal divisions are intensifying, the rift between conservatives and reformists is growing sharper, and the chasms in national interests within the camp are becoming more distinct. This is a typical political phenomenon during economic reform periods. China also confronts the structural reform tasks compelled by the declining birth rate. At this crossroads, there’s no standard answer. Some in capitalism refer to the solution as “Third-Way Capitalism.” On this journey of finding answers, there’s reason to believe that humanity can succeed, production will continue to expand, and more inclusive growth will be realized.