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Cliff Viner writes:

This is important. We’ve mentioned it before. And although the article is about Japan, it applies to many of China’s other export markets.

Yes, the whole global backdrop shifted from a deflationary to an inflationary bias over the last couple of years.

Also, with all of our outsourcing, these imports costs or some extent replace what was unit labor costs in previous cycle.

So in that sense, labor costs are rising faster than our domestic labor numbers indicate.

China Switches From Deflation Exporter To Inflation Exporter

(Nikkei) The prices of Chinese goods are rising in Japan, with sharp increases hitting anything from clothing to audio equipment. If the rise persists, China, which has long underpinned Japan’s steady price structure with its inexpensive products, could become a factor in lifting Japan’s overall price level.

According to a Bank of Japan check on the July prices of imported products, of which more than 50% are supplied by China, polo shirts and gloves cost some 9% more than in July last year. Pajamas and sweat suits also were up 4%. As made-in-China items make up 80% of Japan’s total clothing imports, higher costs can translate into higher price tags at retailers down the road.

The price rise is not limited to clothing. Imports of toys, of which 90% come from China, shot up 10% in July on the year. The price tags on bags, 50% of which originate in China, also climbed 9%. Of audio and video equipment, with the Chinese import ratio of more than 50%, audio devices increased 3-4%. Among other items, China-made cotton cloth, used mainly for bedding and dress shirts, rose to nine-year highs indicating that rising prices of Chinese imports now run the gamut.

Running to a value of 15 trillion yen in fiscal 2007, Chinese products now account for some 20% of Japan’s total import bills. According to trade statistics compiled by the Ministry of Finance, the price index of Chinese imports, which had been falling, rebounded to positive territory in fiscal 2004 and climbed 7.7% on the year in fiscal 2007 with the uptick still continuing.

Increasing prices of Chinese imports are caused in large part by rising wages in that country. Average wages of China’s urban workers rose 18.7% during 2007 over the previous year. Moreover, labor costs in China are destined to rise further with the passage of the labor contract law in January this year which encourages employers to give employees longer contracts.

The substantial appreciation of the yuan is also to blame for increasing the costs of Chinese imports. The yuan’s value rose 20% against the dollar over the three years since Beijing revalued the currency’s exchange rate in July 2005.

So the Chinese factor is casting increasingly dark shadows over Japan’s price picture. “Attention tends to focus on soaring crude oil prices as the main culprit for the recent bout of inflationary pressure, but nearly 10% of the overall increase in imported products is attributable to the Chinese factor,” said Toshihiro Nagahama, chief economist at Dai-ichi Life Research Institute. This is perhaps why many Bank of Japan economists see China as switching, as far as Japan is concerned, from a deflation exporter to an inflation exporter.

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They know how to keep it all going:

(Bloomberg) “Demand for investment is still the one to depend on for dealing with potential external shocks,” because local consumption is not enough to be the main engine of China’s growth, said the center, affiliated with the National Development and Reform Commission. “All levels of government should prepare a list of investment projects in urban transport and infrastructure so that they can be launched immediately once needed.”

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Highlights:

 
Perhaps coming apart with the approach of the Olympics as many have anticipated.

The crowd’s not always wrong!

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(an email exchange)

On Thu, Jun 19, 2008 at 10:38 PM, Russell wrote:
>   
>   
>   SUV sales may be falling off the cliff in the US, but in China, they are red hot.
>   Sales of the large vehicles in China rose by 40% in the first four months of this
>   year. That is twice the growth rate for the Chinese passenger car market.
>   
>   Its no surprise why: The costs of petrol and diesel in China is as much as 40%
>   cheaper than US levels (which are nearly half of European prices).
>   
>   China, the second-biggest fuel consumer after the U.S, has been encouraging
>   SUV purchases via subsidized fuel.
>   
>   That now appears to be changing: The Chinese government will “increase
>   gasoline and diesel prices by 1,000 yuan ($145.50) a ton, the National
>   Development and Reform Commission said,” according to a Bloomberg report.
>   This represents a 17% price increase for gasoline and 18% for diesel. China is
>   also scheduled to raise jet-fuel prices by 1,500 yuan a ton (~25%).
>   
>   The response in Crude futures was immediate: Crude Oil fell almost $5, spurring
>   gains in the broad averages.
>   
>   Demand Destruction is now clearly upon us. Its a cliche, but its true: The best
>   cure for high prices are high prices.
>   
>   

Yes, but…
   
This also means rationing by price which means only the world’s richest get to drive SUV’s and the lower income groups have to take the bus.
   
Distribution of consumption gets skewed towards the top.
   
Interesting that much of the political left wants higher prices to discourage consumption, as its counteragenda regarding their distributional desires.

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Report by Andrew at UBS LIMITED

China - You will have seen in the FT that China plans to encourage its agricultural industry to start buying up land in Africa and Latin America to grow crops on for the Chinese market.

Last year the Chinese National Development & Reform Commission said that China will import the equivalent of 6% of the U.S. corn harvest by 2010. That works out at 38% of U.S. exports or 25% of world exports. A week or two back the Chinese Academy of Social Sciences said that China now has a shortfall of agricultural land equivalent to 17% of what it needs to support its population. Yesterday the Ministry of Agriculture said it is becoming increasingly difficult to sustain self-sufficiency.

This is why global grain prices are soaring, and are going to continue soaring. It is due to top soil mining and water depletion in China, and they are now clearly starting to call on the rest of the world to do the same.

Putting aside the strain this will have on the rest of the world’s land, it also does two other things. Grains have 2 real inputs. Energy (fertilizers) and water. So by importing grains, it is importing embedded energy and embedded water, and on a HUGE scale.

China is running out of water and is going through peak coal production, but rather than buying the energy on the open market and then desalinating the water it needs - (it would require 3% of world oil production to desalinate the scale of water needed just to stand still) - it is going to buy this in an embedded form. It does make some sense in that China has depleted its land so aggressively - (it has lost about 75% of its top soil in the last 30 years, and is consuming way beyond sustainable levels of water) that it will take less energy to produce grains in other parts of the world than in China, BUT that means paying world prices for the energy rather than with Chinese subsidized fertilizer and water prices. Food prices are going to soar. The terms of trade are going to continue to move against China.

You will have seen today that Thailand is warning that its rice yield could fall by 75% by year end. To meet global needs, it is doing a 3 crop harvest this year. That means the land is getting no respite, and the paddy fields are exhausting its water resources. The head of the government’s rice department has warned that this could seriously damage yields for many years, losing it the position as the world’s largest rice exporter. Rice is a very nitrogen dependent crop. That is why it is grown in paddy fields as the water stops nitrogen loss from the soil, and nitrogen rich algae grow on the stagnant water to form a living fertilizer. With the water depleting, Thailand is having to turn to buying nitrogen based fertilizers (natural gas is the cheapest way of making this), adding to the global call on energy.

Quite frankly, food and energy prices are only going one way until Chinese demand is priced out of the market. The problem is that China’s lands and water are so destroyed now, that it is going to become increasingly impossible for it to maintain existing production. Talk of bringing more land in the old Soviet Union or Africa under production seems wishful thinking. If you recall the Soviet Union destroyed its own land in the 1960’s under the various 5 year plans which caused it to import 25% of the U.S. grain harvest in the 1970’s causing the food price rises then. African land quality is also generally poor - (Northern African soils destroyed by the Roman Empire’s over exploitation, and then in recent years the use of fertilizers managed to lift agricultural yields heavily, but the land has deteriorated at the same time), and Africa, like Eastern Europe (and in fact every continent other than North America is a net grain importer. Food and energy price inflation is not a temporary issue, prices are going higher.

Dave from AVM comments on the article:

Good piece, highlights a few more things we have been talking about for a few months:

1. Farming inputs ARE energy and water, energy for fertilizer (NG) and also diesel/kero for farm equipment (together something like 50+% of US farmer’s COGS)
2. Diesel also a call on NG, as “cleaning” fuel (lowering sulfur content) requires hydrogen which is usually a byproduct of active gasoline refining (not this year, yet). In the absence of an increase in refinery utilization rates, hydrogen will be increasingly cracked with natural gas (which is still cheap fuel versus petroleum on a molecular basis)
3. China also importing more LNG on long term contract basis, putting pressure on domestic US natural gas prices (we have to compete for LNG cargos (spot) when there are domestic NG shortages [we have a 300bcf deficit today to last year's levels, before summer cooling demand begins in earnest])
4. Coal issues mentioned are true, but coal still difficult to trade effectively. Better expressed in regional power markets.
5. Abandoning ethanol mandates now (as opposed to Nov EPA vote) to have little impact on ethanol/implied corn demand with crude 120+

We think grains and natural gas prices to rise jointly over next 6 months by 20%+. Power to follow but with extremely high volatility in the summer months, and large positive skew in the shoulders (june and sep).

If food’s as tight as indicated below, world tensions will get a lot worse than anyone currently imagines, including large regional wars.

Eliminating biofuels could buy a few years, cutting national speed limits a few more and perhaps even stabilize things for the next 25 years.

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Interesting statements here. China can’t afford politically to allow growth to slow sufficiently to cut employment growth, inflation not withstanding. This stance ultimately weakens the currency, one way or another:

(Bloomberg) China should stick with its tight monetary policy unless the economy’s expansion slows to below 9 percent, a National Bureau of Statistics official said. “Below 9 percent, it means the tightening is overdone and needs to be loosened,” Zheng Jingping, the bureau’s chief engineer, said at a seminar in Beijing today. The economy expanded by 10.6 percent in the first quarter. Premier Wen Jiabao is balancing the risk of a slump in the world’s fastest-growing major economy against the threat from inflation that is close to an 11-year high. A 1 percentage point slowdown in the U.S. economy will take 5 percentage points off China’s export growth, the Chinese Academy of Social Sciences said in a report today. “A reasonable combination for this year is 4.8 percent inflation and 9.7 percent GDP growth,” said Zheng. Inflation may be between 4.5 percent and 5.5 percent, he added. The government aims to cap price gains at 4.8 percent.

Highlights:

Import Prices from China

This came out earlier today. To me it’s the current day version of ‘unit labor costs’ as much of what used to be US labor content is now sourced in China.

‘Globalization’ has turned from a deflationary to an inflationary influence for the US.

Highlights:

Inflation continues to rip, and my guess is it remains underreported.

Fundamentally, this is not good for the value of the yuan, by definition, but timing is everything…

To the extent ‘actual inflation’ (whatever that actually is- I realize the difficulties in that statement) is higher ‘actual real growth’ (same qualifications) is lower.

Might partially explain high sustained rates of ‘real’ growth?

Highlights:

Still importing heaps, including capital goods.

Inflation is ripping, meaning higher prices for the rest of the world.

Meaning higher prices for US consumers.

Not too shabby.

Articles:

China growth reaches 13-year high

Building and infrastructure projects are fuelling economic growth.

The Chinese economy has expanded by 11.4% over the past year, reaching its fastest growth rate in 13 years, officials have announced.

Increased exports and a boom in the construction industry helped the rapid expansion during 2007.

But officials warned that overheating remained a danger, despite a slight slow-down in the fourth quarter.

Inflation is also a serious concern, with many Chinese people hit by recent dramatic increases in food prices.

‘Still developing’
Announcing the figures, National Statistics Bureau chief Xie Fuzhan said Beijing was paying “close attention” to the US credit crisis.

He said Beijing would respond by making “timely and proper adjustments” in exchange and interest rate policy, but gave no details.

Speculation has been mounting among analysts over whether China has overtaken Germany to become the world’s third-largest economy.

But Mr Xie played down the comparison, saying: “It’s not really important to know whether China is the fourth-largest or the third-largest.

“Even if the total surpasses Germany, China is still a developing country - in particular, the per capita GDP of China is really low.”

China’s 11.2% Fourth-Quarter GDP Gain Props Up Global Growth as U.S. Slows

(Bloomberg) China’s economy expanded more than 11 percent for the fourth straight quarter, supporting global growth as a recession looms in the U.S. Gross domestic product rose 11.2 percent in the three months ended Dec. 31, compared with 11.5 percent in the third quarter, the statistics bureau said in Beijing today.

Industiral output up 18.5%
Industrial output jumped by 18.5 percent last year, 1.9 percentage points higher over a year earlier.

The industrial output at companies with annual revenue of at least five million yuan (US$691,600) expanded by 17.4 percent in December, compared with 17.3 percent in November.

The output growth rates were 13.8 percent for the state-owned enterprises and those in which the state holds controlling stakes and 17.5 percent for companies invested by foreign, Hong Kong, Macao and Taiwan businessmen, Xie said.

The companies sold 98.1 percent of the goods they produced last year.

Industrial output growth decelerated from September onward, as the government’s tightening measures took effect. The year-on-year growth figures for September and October were 18.9 percent and 17.9 percent, respectively.

Output growth rates were 13.8 percent for state-owned enterprises and organizations in which the state holds controlling stakes and 17.5 percent for foreign-, Hong Kong-, Macao- and Taiwan-invested businesses, Xie told press conference in Beijing.

Highlights:

Yes, but…