At this point most people will acknowledge that Europe is facing the threat of deflation – they might think that the European Central Bank is willing to do what it takes to push inflation back up, but the issue can’t really be ignored. But the focus on just one measure of inflation, consumer price index, may be understating the possibility of deflation elsewhere.

Albert Edwards: China’s nominal GDP growth at lowest point since 2008

“The most important economic news over the Easter break was virtually wholly overlooked,” writes Societe General analyst and renowned bear Albert Edwards. “China’s Q1 GDP was highly significant, not for the headline slowdown in GDP growth to 7.4%, but because economy-wide inflation slumped further towards outright deflation.”

China’s nominal GDP growth rate fell from 9.7% in 4Q13 to 7.9% last quarter, and the GDP deflator fell from 1.4% to 0.4%. Albert Edwards realizes that many people don’t bother looking at nominal GDP growth, but he thinks this is a mistake. If you only looked at CPI, you would have the impression that Japan has been suffering for the last twenty years because its inflation hovered around zero, while the GDP deflator gives a sense of the true scale of the problem.

japan CPI GDP 0414 Albert Edwards

China’s GDP deflator hasn’t turned negative yet, but it is at lowest point since the 2008 recession and it is now well below CPI. If it does go negative in the next few quarters it will mean that indebted Chinese companies could suffer the same fate as indebted Japanese companies did in the 1990s, with many of them becoming insolvent.

China CPI v GDP 0414 Albert Edwards

Albert Edwards’ market-based core PCE shows deflation threat in the US

Albert Edwards argues that CPI is overstating the inflation rate in the US as well, preferring to look at market based core PCE (personal consumption expenditure) because it “excludes numbers the statisticians have to make up.” While core CPI says that inflation is healthy and rising, and core PCE shows inflation as quite low but holding steady, the market-based core PCE that Albert Edwards cites shows the US sliding towards deflation as well.

US core CPI 0414 Albert Edwards

In a vacuum, the U.S. might not have a problem, but if China follows Japan’s lead and decides to export deflation by devaluing its currency just as the Fed is trying to end QE and reduce liquidity, deflation could become a major concern. According to Albert Edwards, that’s why the US Treasury has once again ramped up its efforts to get China to liberalize the renminbi – Treasury is preparing for the worst.