The Chinese economy is slowing. Producer prices in China have been falling for nearly three years. Consumer prices have dropped to a five-year low making the Eurozone’s problems with deflation look tame

In the United States in July of 2008, a litre of gas reached an all-time high of $1.08. I suspected something. I had read earlier articles about shortages in China. In February, there were reported lines at gas stations. The Olympics were to be held in Beijing that year and I did not think that the Chinese wanted to make a bad impression. Interestingly enough, two weeks before the games, the price of gas started to fall. With the addition of the Great Recession, the price fell to $0.42 a litre, a collapse of over 60%. I could never prove it, but I suspected that demand from China pushed the price of gas to its all-time high.
 
This year the price of oil has dropped 38% since June. Again, I suspect China has something to do with it. The Chinese economy is slowing, but exactly how fast, might be difficult to tell given the Chinese predilection for messing with the numbers. Certainly, the fall of commodities including steel, iron and coal are obvious, because China is the world’s largest consumer.
 
Oil is a bit different. This is because USA consumes almost twice the quantity of oil as compared to China. China’s consumption has been catching up until now. Since 1999, the rate of China’s demand for oil has been rising. This has recently changed. The forecast for the growth of China’s demand has been lowered five times this year. In fact, imports dropped 22% in October alone and China actually became a net exporter.
 
The drop in the demand for oil tells you something about the rate of China’s contraction. This is hardly surprising. According to a Chinese research paper, the years of government stimulus resulted in massive inefficient investment and misallocated capital. How much is astonishing. The paper put the level at $6.8 trillion. This level goes a long way to explain the “ghost” cities and the bridges to nowhere. But, since this is China, the estimates are that $1 trillion was simply stolen.
 
The mis-allocation of capital resulted in excess capacity. Too many competitors producing the same product drives prices and profits down. Without profits, loans can’t be repaid. To just keep up with the interest requires more debt. Without bankruptcy, the cycle repeats.
 
The producer prices in China have been falling for nearly three years. Consumer prices have dropped to a five-year low making the Eurozone’s problems with deflation look tame.
 
However, dropping prices in China affect everyone else. All of the commodities that have been driven higher by demand from China including copper have been rapidly falling. The fall in commodity prices temporarily help profit margins for corporations in other countries, but not for long. With lower inputs, prices can fall further, exacerbating and spreading deflation already a problem in Europe and Japan.  
 
On Thursday, the 4th December, a possible market rout was stopped by an unofficial, uncorroborated anonymous report that the European Central Bank would begin QE in January. The report contradicted ECB President Draghi’s statements in his press conference a few hours before. The markets decided to ignore the public official statements and go with an unconfirmed anonymous report. The markets also ignored an article in the fourth largest German national newspaper, Die Welt, that Draghi no longer had a majority on the board. Whether they will be able to ignore falling commodities, slower growth and deflation is yet to be seen.

(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first-hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and speaks four languages.)