By: Our Correspondent

The startling Producer Price Index figures that emerged from China Wednesday may presage even more startling consumer price index figures Thursday. The result may be what was unthinkable as late as two months ago:  China could follow Japan into deflation, especially as the Lunar New Year approaches and China's consumers traditionally pay their debts and stop spending in order to ensure a prosperous new year.

That was followed by later news that China’s export and import growth collapsed in November, with exports  shrinking by 2.2 percent annually from near record growth of 19.2 in October. Import growth fell from 15.6 percent in October to minus 17.9 percent year-on-year in November, resulting in another record high trade surplus of US$40.09 billion. It is the first time in more than seven years that exports went negative.

The good news, if there is any, is that falling fuel and commodity prices, plus Beijing's success in boosting its food supply, resulted in a dramatic drop in the Producer Price Index, which measures the average change in selling prices received by domestic producers of goods and services.  The PPI peaked in August at 10.1 percent annually, then dropped by 6.6 percent in October before plummeting to just 2 percent in November. As evidence of the turnaround, as late as June, inflation in China hit a 12-year high, forcing the central bank to shift to a tight monetary stance after raising interest rates by 0.18 percentage points earlier.

China's economy, however, appears to be going into the tank faster than anybody foresaw.  The crisis is already hitting thousands of toy and textile manufacturers in Guangdong as western economies stop importing. It is estimated that half of all of China's toy manufacturers have disappeared in the last year and a half. In Shaoxing Province, Chinese media reported Wednesday that the chairman of Zhejiang Zongheng Group is under house arrest because of financial difficulties. China Printing and Dyeing, another Shaaoxing company, stopped production in October and its chairman disappeared after having forced his employees to borrow more than Rmb80 million.  These kinds of stories are being reported all over China.

In an effort to make exports more competitive, the central bank depreciated the currency by 0.79 percent against the US dollar last week, ending two years of creeping upwards against the US currency. Earlier, the government formulated a massive Rmb4 trillion ($581 billion) spending plan for infrastructure and other construction, plus adding to the social safety net.  That has been followed by a wide range of other spending plans.

Until quite recently, the majority of economists were predicting that China would be the engine of growth that would save the world economy, which has been slipping into recession since at least November 2007.
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By October 2008, it was increasingly apparent that wasn't going to happen.  As credit and equity markets collapsed in the European Union and the United States, the financial downturn headed east.

In October, industrial output fell to 8.2 percent, energy production fell by 3 percent, cement and steel output fell sharply – steel by 16.4 percent — and bank loans virtually dried up.

Although car sales bounced up by 12 percent in October, in November sales to dealers fell by a full 10 percent, the steepest fall in three years.

Although the Chinese consumer remains the strongest part of the economy, with retail sales growth a near record at 22 percent annually, it was clear that trouble was coming. China's risk-averse consumers began putting their money into the bank instead of spending it starting in mid-2007, according to an estimate by UBS, the Swiss investment bank, with household deposits rising from about 7 percent of income to well over 25 percent.

"Factoring for both over-supply in the domestic market and the weakness of international commodities prices, we have cut our whole-year average CPI for 2009 from 2.5% previously to minus 0.2%," said Qu Hongbin, HSBC's China economist.

"While falling inflation is at least partly caused by a positive shock in the domestic supply of meat and food, the central bank must come out with strong and quick policy responses to prevent deflation expectations from being built in. Combined with much needed credit easing to accommodate fiscal stimulus, this means that the central bank will have to maximize its efforts to ease policy in the coming quarters."

In all, that means China is in for a rough ride, and any hope that its economy will tow the west along is probably a forlorn one. Instead, China's leaders, always concerned about stability, have had to start looking at the 150 million-odd largely unskilled and unemployed workers who are already on the move. 

That said, however, with US$1.4 trillion in foreign reserves, a highly liquid financial sector, households, banks and companies with clean balance sheets able to take on more debt, China is probably in a better position than the flagging US or Eurozone economies. Beijing, extremely concerned about the millions of its out-of-work citizenry, is coming up almost daily with new stimulus plans to try to keep them from rioting in the street.