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Desperate Discounts? How China’s Export Woes Are Fueling Domestic Deflation

•  As U.S. tariffs choke off overseas sales, China is dumping excess inventory at home, driving deflation fueled by desperation, not innovation.   
  
  
• Falling prices may seem good for consumers, but for Chinese sellers, it means shrinking profits, rising debt costs, layoffs, and an economic squeeze.

What you need to know: As U.S. tariffs curb overseas demand, China is pushing exporters to sell at home, risking deeper deflation in an economy already drowning in weak consumption and excess capacity¹. 

Why it matters: As excess inventory (that can’t find buyers abroad via tariffs) floods a domestic market already plagued by weak consumption, it’s fueling deflation not from innovation or efficiency, but from desperation. Prices are falling because firms are slashing margins to try and move product and stay afloat, deepening the very economic fragility that China has dealt with for years. 

Now the Deep Dive: Without the U.S. market to offload excess goods, China’s deflation problem is deepening — prices are falling, not from innovation or efficiency, but from desperation. Companies are cutting prices to move products, and it’s exposing a deeper problem: a dangerous mismatch between oversupply and anemic demand.

Now you might think, “Aren’t falling prices good for consumers?”

If you’re a buyer, yes, that's right. But China’s consumer is already anemic — not spending enough to absorb the glut of goods.

And if you’re a seller? Deflation is a nightmare. It means the products you sell are losing value faster than you can sell them.

• Deflation is also brutal for debtors as it increases the cost of debt in real terms. And China has a lot of debt.

That’s where the PPI-CPI spread comes in:

• PPI (Producer Price Index): Measures wholesale inflation (what suppliers pay).
  
  
• CPI (Consumer Price Index): Measures consumer inflation (what they pay)

Just take a look at the chart below.

When PPI is higher than CPI (yellow bar positive), manufacturers can pass rising costs to consumers. But when PPI falls below CPI (yellow bar negative) — like now — it signals a profit squeeze as companies face rising input costs but can’t raise retail prices because there’s no demand - thus leading to layoffs, bankruptcies, and economic malaise.

• Aka if the spread is negative for an extended period, it suggests that manufacturers (producers) are struggling.

Now, China has dealt with this before (a few times, actually).

But in the past, they could mask domestic weakness by exporting their surplus of goods abroad. But now, tariffs are blocking that escape route. So, they’re flooding the domestic market instead, cutting prices further to survive.

At first, dumping unsold exports at home looks clever. But when it becomes a strategy, it’s a liability. It breaks pricing power, weakens earnings, and triggers another round of cost cuts — all in an economy already drowning in debt and overcapacity.

Beijing has hesitated to stimulate demand directly (by handing cash to consumers). But with deflation deepening, they may be forced to (although I think it would have limited benefit at this point).

Watch this closely because it’s not just China’s problem. Other export-heavy economies may be next. 

Figure 1: MacroMicro, May 2025

Debt, Trade Wars, and Housing Bubbles: Is Canada on the Brink? 

• The Bank of Canada warns that a prolonged global trade war could lead to more Canadians missing mortgage payments than during the 2008 financial crisis — potentially bursting the nation’s housing bubble.
  
  
• Canada’s dangerously high household debt — with consumers owing $1.73 for every dollar of income — leaves the country highly vulnerable to economic shocks.

What you need to know: The Bank of Canada warned that a long, brutal global trade war could cause more Canadians to miss mortgage payments — even more than during the 2008 financial crisis — and might burst Canada’s housing bubble². 

Why it matters: Canada is caught in the middle of a massive debt-fueled housing bubble, with consumers heavily leveraged. The longer a trade war drags on, the greater the risk for Canadians, as potential job losses and slowing growth could trigger a housing bust.

Now the Deep Dive: I’m not here to pick on Canada, but we need to take a closer look at what’s going on.

I believe there are two major risks looming over the Canadian economy right now:

1. Businesses Overexposed to U.S. Exports Are in Danger.

Companies that live and die by U.S. exports- especially in manufacturing sectors like transportation equipment and primary metals - are in the danger zone.

• Out of the 15 top U.S.-exposed subsectors, 12 are in manufacturing - sectors that are getting hit hardest by tariffs.
  
  
• Businesses that export a large share of their production to the U.S. and have high debt, low profitability, and weak cash reserves are particularly vulnerable.

This means lost jobs, shrinking incomes, and struggling businesses in these industries.

2. Canadian Households Are Deep in Debt.

Canada’s household debt-to-disposable income ratio is 173% at the end of 2024. That means for every dollar of income, Canadians owe $1.73. (That's not sustainable.)

• For context, the U.S. ratio is around 100%.

Meanwhile, despite having an average income (or GDP-per-capita) of roughly $54,000 USD (slightly more than Mississippi)³, Canadian home prices are as steep as California’s.

• Median U.S. home price: $403,000 USD.
• Median Canadian home price: $522,000 USD - or a ~30% increase. 

So, how do you afford a California-priced home on a Mississippi-sized income?

Debt and years of low interest rates. 

But now it’s already taking a toll even as the Bank of Canada cuts rates. Even before the trade war started, Canadian households were missing payments at a worrying rate, with debt burdens becoming overwhelming⁴.

Thus, further delinquencies could trigger a debt and housing crisis - possibly even a banking crisis (although that’s speculation).

Meanwhile, there’s evidence that Canada’s once-hot housing bubble is deflating as an affordability crisis deepens.

So, the warning signs are there. Canada’s economy is increasingly strained, and the longer these trade disputes continue, the worse things could get.

Thus, if our northern neighbors can’t rein in their debt during a trade war, Canada might become the world’s most polite economic cautionary tale.

Figure 2: Bank of Canada, Dunham May 2025 

Taiwan Dollar Soars to 1988 Highs: A Warning for Exporters and Insurers

• Taiwan’s currency experienced its sharpest surge since 1988, triggering panic among exporters and insurers deeply exposed to U.S. dollar-denominated assets. 
  
  
• This unexpected appreciation is prompting Taiwanese financial giants to hedge dollar exposure despite high costs and is sparking calls to rethink Taiwan’s export-reliant economic model. 

What you need to know: Taiwan's currency surged against the US dollar in early May — its sharpest jump since 1988. Exporters and insurers are rattled, fearing more pain ahead⁵. 

Why it matters: A stronger Taiwan dollar can erode the competitiveness of Taiwanese exporters by making their goods more expensive abroad, while also straining insurance companies with increased liabilities on foreign-currency policies. The sudden and unexpected surge has triggered concerns about market volatility, threatening the island's export-driven economy. 

Now the Deep Dive: Funny how timing works out.

Just last week, I wrote to you in “Why Falling U.S. Stocks and a Weak Dollar Are Hurting Foreign Investors – and What Comes Next,” warning of the great risk for massive foreign institutions — pension funds, insurance companies, sovereign wealth funds — holding tens of trillions in U.S. dollar-denominated assets.

The core thesis was simple. These foreign “financial whales” hold a massive pile of U.S. dollars and U.S. assets. Thus, if the dollar weakens and U.S. markets fall, they bleed. (Click here for more context).

Well, a few days later, Taiwan proved it.

As of Tuesday, its currency (the Taiwanese dollar; $TWD) surged higher against the U.S. dollar — its sharpest surge in nearly four decades.

Exporters panicked, and life insurers did too. In fact, it got so bad that regulators had to call an emergency meeting to discuss it⁶.

Why? Because Taiwanese insurers hold over $700 billion in overseas assets — more than half in U.S. dollars and U.S. markets.

This is why that matters. . .

• You’re a Taiwanese insurer investing in U.S. stocks.
• You convert Taiwanese dollars to U.S. dollars.
• If the dollar strengthens, your returns grow when you convert back.
• But if the dollar weakens? Your gains get eaten into.

Now these financial giants are becoming more likely to hedge their dollar exposure — but hedging costs are brutal, nearing 15%.

And a stronger Taiwan dollar? It’s a blow to Taiwan’s exporters — a key driver of growth and government cash flow. This shock has already triggered calls to rethink Taiwan’s export-driven model, echoing Japan’s painful experience in the 1980s (which I wrote about two months ago).

But this isn’t just Taiwan’s crisis. It’s a warning. Because when a rising currency slams into massive foreign exposure and export-driven economies, the fallout could be brutal.

I don’t think this ends with Taiwan. Other major surplus countries could see their currencies surge too — and feel the same pain.

• The record-breaking rally in Taiwan’s dollar triggered a wave of currency surges across Asia - impacting Singapore, South Korea, Malaysia, China, and Hong Kong⁷.

But as always, I’ll keep you updated. 

 Figure 3: Bloomberg, May 2025

Anyway, who knows what will happen?

This is just some food for thought as we watch how these trends develop.

As always, we’ll be keeping a close eye on things. Enjoy the rest of your weekend.

Sources:

1. China risks deeper deflation by diverting exports to domestic market
2. Financial Stability Report—2025 - Bank of Canada
3. How Canada Would Rank as the 51st State
4. Gap widens between financially stable Canadians and those struggling with debt, says report | CBC News
5. Taiwan Dollar's Surge Steps Up Pressure for Economic Overhaul - Bloomberg
6. Taiwan Regulator Meets With Life Insurers as Currency Surges - Bloomberg
7. 'Asian crisis in reverse' as currencies soar on the dollar | Reuters

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