China's economy grew at an annualized 7.4 percent in the first quarter (Q1) of this year. This number was just above analyst expectations, but marked a slowdown from the 7.7 percent increase seen in the last quarter of 2013.
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"China's Q1 GDP was highly significant, not for the headline slowdown in growth… but because economy-wide inflation slumped further towards outright deflation," Edwards wrote.
He highlighted the country's GDP deflator – a broader measure of domestic price trends, including investment goods, housing and exports, as well as consumer goods and services - dropped by 1.4 percentage points to 0.4 percent year-on-year.
Fears of deflation have been mooted in the euro zone, where consumer price inflation fell to a 52-month low of 0.5 percent in March. By contrast, China's annual consumer inflation was 2.1 percent last month.
"(This) may be giving investors an overly reassuring impression of underlying deflationary pressures in the Chinese economy overall," Edwards wrote.
Economists are concerned by deflation because it can push down demand, with people holding off purchases in the hope of more price declines. This, in turn, can lead to lower production and an economic slump – or even a depression.
Japan, for instance, suffered deflation during its "lost decade" between 1991 and 2000, when companies cut prices to revive lackluster demand, which in turn hit businesses' revenue and had a knock-on effect on the economy.
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"Indeed, focusing on the consumer price index (CPI) in Japan, rather than the GDP deflator, would have underestimated the deflationary hurricane that was raging in Japan… Let us not make that mistake for China," Edwards added.
Risk of US deflation?
As the world's second-largest economy, the effects would be felt across the world if China slid into deflation – even in the U.S., Edwards warned.
"We have long banged the drum that deflationary developments in China would force renminbi devaluation and trigger outright deflation in the West," he said.