Wednesday, September 05, 2007

China's Newest Export: Inflation

Ben Bernanke, the Fed Chairman currently living the nightmare of the Alan Greenspan's free-money daydream, has publicly downplayed the immense benefits reaped by the American Consumer from China's deflationary manufacturing arbitrage, as we quoted in "Fed Big Flunks Eco 101" back on March 7, 2007:

Globalization hasn't had a significant impact on reducing inflation in the U.S. and may have raised it, Federal Reserve Chairman Ben Bernanke said.

—Wall Street Journal

Now, Mr. Bernanke may have been a great economist before succeeding Alan Greespan to the head of that class of academic thinkers, but he clearly never shopped at a Wal-Mart, or a Costco, or even a Safeway, for that matter, during the 1990s, when prices across America were falling thanks to the China arbitrage.

Indeed, if he had just wandered into a Best Buy now and then he would have seen what every retail CEO in America knew first-hand: stuff made in China cost a lot less than stuff made anywhere else, and those retail CEOs were pushing every one of their vendors to get with the program.

But not Mr. Bernanke.

Still, he did make it to the top of the economic pile. And, as the saying goes, even a stopped watch is right twice a day. So it looks like Mr. Bernanke's views on China's inflationary impact might, finally, be right.

While it is no secret that labor costs, and environmental costs, and energy costs are rising, along with the cost of just about everything else China needs to feed the manufacturing beast that now supplies American with 8 out of 10 everything, according to government statistics I just made up, the magnitude of the overall cost increase is certainly a shock to at least one major retailer of Chinese-sourced goods.

Like, 50% shocking.

I am not making that up: word out of one significant retailer is that some of the China-sourced merchandise they were expecting to cost, for example, $10 a unit prior to packaging, shipping, handling and mark-ups, is coming in at $15 a unit.

Now, after checking with other companies that also source in China, 50% gap-ups is not the norm.

But 10% is not unheard of, making companies work extra hard on packaging and distribution costs to get the entire impact down to a more manageable 5% or so.

Which, last I heard, was more than double Mr. Bernanke's inflationary "comfort level."

But, then again, since according to Mr. Bernanke's view of economic history, China never helped us when it came to inflation, then perhaps China will never hurt us.

It's a win-win all around!

Jeff Matthews
I Am Not Making This Up

© 2007 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.


Alex Khenkin said...

Jeff, believe it or not, but Bernanke may have been right when he said that China was, perhaps, even exacerbating inflation pressures in the US. Taking the definition of inflation as expansion of the supply of money, of which raising prices may be but one symptom, we can clearly see that the Chinese made the problem worse. How? By recycling our dollars right back to our economy, of course, via Treasury purchases.
Small Investor Chronicles™

buckeye1 said...

Hilarious, government statistics you just made up! They just made some up to refute you as well. The Chinese bubble is going to pop at some point and things are going to get very ugly in a wide variety of asset classes. Wish this wasn't the case but it is the inevitable conclusion I have come to unfortunately.

BBL Jr said...

I wrote about this same thing recently but you did it so much better. (}

BelowTheCrowd said...

All this depends on what you define as "inflation." If you use the typical government-adjusted and made up numbers that exclude much of the stuff you need, and count all the stuff you want, then you could definitely say that China has helped keep inflation in check. But if you look beyond that, you would note that:

* Chinese demand has certainly contributed to the huge increase in the prices oof gasoline and other energy sources in the past five years.

* Chinese demand has clearly contributed to the cost of all varieties of foodstuff.

* Chinese willingness to recycle their dollars has contributed tremendously to the easy money environment that has allowed the real cost of housing to double in many markets in just a few years. (Real cost of housing = cost of actually buying a house, not the government favored, acadmically-sound, inflation-eliminating "owners equivalent rent.")


eeeeeekonjohn said...

for a counterpoint, the economist touched on this last month:

It is the weak dollar, not cantering cost inflation in China, that is to blame for higher American import prices. China's manufacturing costs and export prices in yuan terms are still falling overall. The surge in consumer-price inflation is entirely due to higher food prices, which do not affect export prices.

Nor is China close to running out of cheap labour, as some commentators suggest. There are shortages of managers and skilled workers, but it could take at least another decade before China's surplus rural labour is fully absorbed by industry. It is true that average wages have jumped by 15% over the past year, but productivity in manufacturing has been growing faster still, so unit labour costs have fallen. Moreover, those productivity gains—ie, a higher value of output per worker—partly reflect a shift in the mix of exports towards higher-value goods. This shift, misleadingly, makes it look as if China is charging more for its exports.

Anonymous said...

Jeff: I came across an interesting article on Bloomberg today which mentions how our trading partners from the Far East (i.e., China, Japan and Singapore) are slowly reducing their holdings of US Treasuries. Readers can see the article by clicking here. I wonder what a weaker dollar will do to inflation in the US and what that means or long term bonds (think TIPS for example)?

Brad Meikle said...

Having spent a fair amount of time in China its clear that like the US the govt inflation #s are understated.

If we go back to 2002 and Greenspan's 550bp of interest rate cuts, productivity gains were the big reason for why inflation didnt crop up when it should have. No, in reality China was exporting deflation through the end of 2004 by enabling Costco, WMT, Target to import goods at a cheaper price and keep domestic pricing down. Now however those prices are going up, plus there is still the residual effect of the excess created liquidity that has to be dealt with. In 1998 it resulted in the dot-com boom. This cycle the outcome was merger mania which in time it will be clear was completely excessive, peaking in some very overpriced/non-typical lbo deals - like Freescale a chip company which has all sorts of issues.

Now that the currency has been thoroughly debased in order to prop up short term demand at the expense of the dollar, we are left with a plunging dollar. This will limit how much Bernanke can cut rates and inflation will continue to be an ongoing battle. It seems this Tuesday and following weeks is going to be very disappointing for the bulls.