We have been warning of China being in the grips of deflation. If it becomes entrenched, which is a realistic risk, the downside is considerable. Deflation leads to business closures, falling incomes and job losses. Those effects can then kick off a deflationary spiral. Bad economic conditions and falling prices lead businesses to hunker down and defer spending, which then intensifies the contraction. On top of that, falling prices increase the cost of debt in real terms. That produces defaults, which reduce investor incomes and can lead to bank failures, or at least to a great reduction in new lending, again amplifying the depression.