China’s surprising deflation export: A closer look at Cathie Wood’s insight

At the core of Wood's observation lies a conventional economic principle: when a country's currency depreciates, inflation usually rises.

In a stimulating tweet on August 15, a prominent American investor Cathie Wood drew attention to a confusing economic trend that might have significant implications for global economies.

She shed light on how China is exporting deflation in a way many economists are able to fully comprehend currently, tweeting, "China is exporting deflation in a more profound way than I believe many economists and strategists appreciate. All else equal, the 15 percent depreciation in the yuan relative to the dollar in the last year should have increased its PPI (Producer Price Index) inflation rate by 15 percent. Instead, it has dropped 4 percent.”

This tweet sparks curiosity and urges us to dive deeper into the dynamics of currency depreciation, inflation and global trade to understand this phenomenon.

At the core of Wood's observation lies a conventional economic principle: when a country's currency depreciates, inflation usually rises. This happens because a weaker currency makes imported goods more expensive, leading consumers to opt for domestically produced goods, which, in turn, can drive up prices. This effect is often reflected in the PPI, which tracks price changes for goods at the producer level.

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However, China seems to be operating in a different economic realm. Over the past year, the yuan has depreciated by around 15 percent against the dollar. According to traditional economic logic, this depreciation should have caused China's PPI inflation rate to surge by an equivalent of 15 percent. But the reality is remarkably different — the PPI inflation rate has dropped by 4 percent instead, as Wood pointed out.

Unravelling this apparent paradox requires a deeper analysis. One key factor is China's role in the global supply chain. As a significant manufacturing hub, China produces intermediate goods — components used in various stages of global production. When the yuan weakens, these intermediate goods become more attractive to foreign manufacturers due to lower costs. This can lead to downward pressure on the prices of finished products, counteracting the inflationary effects that would typically follow currency depreciation.

Additionally, several other factors contribute to this unique situation. China's consistent issue of overcapacity in certain industries, coupled with technological advancements, might be mitigating the anticipated inflation effects. Furthermore, fierce global competition in sectors like manufacturing could be driving prices down, further offsetting the expected impact of currency depreciation on inflation.

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The Chinese government's strategic currency interventions also play a part. By deliberately allowing the yuan to depreciate, China could enhance its global competitiveness without triggering runaway inflation — a delicate balancing act that shapes its economic landscape.

Wood's tweet serves as a reminder that real-world economies often defy simplistic models. It emphasizes the importance of considering a broader range of factors to understand economic trends fully.

Who is Cathie Woods?

Cathie Wood is a star stock-picker and founder of the $60 billion (assets) ARK Invest, which invests in innovations like self-driving cars and genomics. After stints at other investment firms, Wood created ARK in 2014 hoping to package active stock portfolios in an exchange-traded funds format. Her flagship $23 billion (assets) Ark Innovation Fund has returned an average of nearly 45 percent annually over the past five years.

Wood studied economics at the University of Southern California under Art Laffer, the inventor of the Laffer Curve, which theorizes the tie between tax rates and tax revenue. Wood is one of the biggest backers of Elon Musk's Tesla. She predicts the electric car company will someday be valued at over $3 trillion.