A technical flaw in constructing the GDP deflator might be good news (sort of)

CHINA FINANCIAL - In Brief 05 Jun 2015 by Michael Pettis

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I've long argued that a non-disruptive adjustment would require that China's annual GDP growth decelerate by a minimum of 100-150 bps during the rebalancing period (which probably began in 2012). Reported GDP growth was 9.3% in 2011. In 2015-Q1 it had dropped to 7.0% year on year -- a sclerotic 230 bps deceleration, rather than the 320-500 bps I had hoped for. However Capital Research (CR) recently pointed out that, like in many developing countries, China's data quality is too poor to let them exclude the impact of imports when calculating the GDP deflator. This technical flaw means that the GDP deflator will automatically be overstated when import prices are rising, and understated when they are declining. This has at least two important implications: First, 2011 reported GDP growth was understated by rising commodity prices in 2009-11, and reported GDP growth in 2015 Q1 was overstated by the 2013-14 commodity price collapse, with CR saying that annual GDP growth in 2015-Q1 should have been 5-6%, not 7.0%. Reported deceleration since 2011, in other words, might have been roughly 450-550 bps, not 230 bps. Second, when commodity prices stabilize (perhaps 2015?), GDP growth will automatically drop to a more "correct number", but for technical, not real, reasons. Debt is still growing way too quickly, and GDP growth will drop much more, but China's adjustment since 2011 was probably greater than reported. Maybe the odds of a non-disruptive adjustment have increased a little.