• Jeff Matthews

China’s Next Great Leap Forward: Inflation

Yuan Takes Baby Steps Higher China Looks to Balance Pressure From G20 Against the Worries of Its Exporters

BEIJING—A week after China loosened its grip on the yuan, the currency is up just 0.53%, a barely visible gain that lived up to the government’s promise to restrict the pace of any appreciation…

—The Wall Street Journal

Thus the Wall Street Journal discussed, earlier this week, the rise of the Yuan in the wake of the long-awaited and much-hyped shift to a flexible currency in a country not much given to flexibility.

And that policy shift preoccupied Wall Street for all of, oh, maybe 15 minutes.

Then, like our dog Charles, Wall Street got distracted by other shiny objects, such as Greek credit default swaps, World Cup Soccer, and yesterday’s Consumer Confidence Index—soon to be renamed the Consumer Anxiety Index.

But having heard more than one company discuss the increasing difficulty of sourcing low-cost manufacturing in China, we sought the counsel of a long-time acquaintance who made a business of manufacturing in China, and who has, over the years, provided a sharp, clear-eyed view of just such issues as the value of the Yuan and what it means for products made in China.

And what it means is not nearly as important as something else going on in China. What is going on is this: costs in China are rising, and they will continue to rise for years to come. In fact, he said, costs will rise the rest of the decade at a rate that places China among the higher-cost manufacturing areas of the world.

And it has nothing to do with the Yuan.

What it has to do with is China’s “One-Child Policy.”

31 years ago, Deng Ziaoping (look him up, kids), declared a “One-Child Policy,” which is still policy today. And that policy, while not precisely one child (if a couple’s first child was a girl, the couple could have a second child), reduced the number of children-per-females from almost six in 1970 to roughly two today.

Thus, as our manufacturing friend pointed out, the demographics in China are shifting rapidly from a surplus of labor to a shortage. And by “rapidly” he means “the next three years,” when the 18-25 year old population drops by something close to one-third.

Now, the effect of this mind-boggling demographic shift was already felt, early this year. After the Chinese New Year, a number of U.S. companies reported that an unusual number of factory workers failed to return from their inland homes, reducing their manufacturing efficiency, increasing costs-per-item, and forcing a shift to airfreight in order to get product to markets on time. What is happening is this: as China promotes economic expansion away from the crowded south, jobs are opening up where none had been before.

To put numbers on it, according to our acquaintance, some factories were 25% short of labor after the Chinese New Year, and thus operated at as little as 75% of capacity.

And this problem for the manufacturing base in China is not going away: in fact, it will get worse as the labor surplus dries up.

After all, as our friend said, “If you could work in an office building near home instead of traveling a thousand miles back to a hot, dark, cramped, noisy factory—and make more money—wouldn’t you?”

We would indeed.

Jeff Matthews I Am Not Making This Up

© 2010 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews, who also acts as an advisor: 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 investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.

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The content contained in this blog represents only the opinions of Mr. Matthews. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. The content herein is intended solely for the entertainment of the reader, and the author.

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