China Unlikely to Export Inflation

Summary

• Chinese exporters are experiencing cost pressures but seem unable to pass them on to their customers.
• Chinese exporters’ lack of pricing power could reflect the country’s attempt to move into higher value-added exports and massive currency appreciation since the mid-2000s.
• Even if Chinese export prices were to rise, this would be unlikely to impact the US CPI due to weak passthrough.

Market Implications

• Medium term positive bonds.

Chinese Exporters’ Pricing Power Has Been Weakening

Recent increases in China’s PPI and the price of US imports from China saw some market participants warn that China is starting to export inflation (Chart 1). But as Chart 1 shows, Chinese global export prices (an index computed by the Netherland Bureau for Economic Policy Analysis) have become less sensitive to accelerations in Chinese PPI inflation, and the price of US imports from China even less so. This suggests weakening pricing power for Chinese exporters.

Global trade data confirms this weak pricing power. China’s global export share increased rapidly before the GFC, but that increase came with an 11% decrease in Chinese export prices relative to global export prices. Without such a price decrease, China may have been unable to increase its global market share so fast.

Since the GFC, Chinese export prices have increased faster than global prices, but Chinese export share gains have slowed. And since 2016, they have virtually stopped, despite a decline in Chinese export prices relative to global prices (the 2020 surge in China’s export share likely reflects that the country was first to normalize its economy; the surge is unlikely to last beyond the normalization of the world economy). This suggests that China may be unable to raise its export prices without losing export share, which China’s political leaders would want to avoid because of the negative impact on employment.

Yet another sign of China’s weak global pricing power is the evolution of its terms of trade, i.e., the ratio of export to import prices. With rising terms of trade, a country needs fewer exports to pay for its imports. China’s terms of trade are currently barely above their level in 2000. This is due to a 15% decline before the GFC: China’s rapid expansion pressured commodities prices, a key import, while the country lacked the market power to pass on the increase in costs to its export customers.

The pre-GFC increase in Chinese exports is unprecedented. However, the increase has been decreasingly beneficial to the country since it has needed ever-more exports to pay for its imports. Since the GFC, China has raised its export prices and managed to recoup the pre-GFC terms of trade losses. But this has come with slower export growth.

China’s pricing power and market share difficulties could reflect its attempt to move into higher value-added exports and its exchange rate policy. China is engaged in a multi-year transition to upper-income status involving the export of higher value-added goods where the established players are largely DMs. This is a difficult transition. Success requires quality and low prices, which very few countries have managed – South Korea was the last such example.

While seeking to move into higher value-added export lines, China has simultaneously engaged in multi-year currency appreciation. Its nominal and real trade-weighted exchange rates increased by 60% and 65% respectively since 2005. Indeed, CNY appreciation more than explains the increase in China’s USD export prices. China’s current difficulties with pricing power and global export share could place a ceiling on future CNY appreciation.

Finally, China could also be reluctant to raise its export prices due to the risks of tariffs and sanctions. If anything, the Biden administration has adopted a tougher stance on China than the Trump administration. Furthermore, the Biden administration seeks to build global coalitions to apply pressure on China. In this context, Chinese exporters could be reluctant to increase prices so as not to compound the commercial disadvantage that additional sanctions would entail.

Limited pass through from US import prices to US CPI

While US core import prices and the price of imports from China tend to move in sync, the passthrough from core US import prices to PPI is limited. And the passthrough from PPI to CPI is even weaker. Indeed, there was only a limited impact on the core goods CPI from the 2018 tariffs imposed on China. Goods price deflation slowed rather than reversed. Regardless, core goods represent only 20% of the CPI basket.

This discussion suggests that fears of US and global inflation could be misplaced and supports lower BEs.