The prices, particularly of manufactured goods, in the shops are a lot lower because of the Chindia factor and this today extends further. Why would an American pay $100,000 for a heart transplant when he can go to India and get as good, if not better, for a fraction of the price? If you were a developer, why would you pay an architect in Mayfair to design your building when an architect in Beijing might do it just as well for much less?
The inevitable process that is underway is a long-term pernicious undermining of our quality of life to allow for the improvement in the quality of life of the three billion new Chindia entrants to the capitalist world. The standard of living throughout the world will, over time, move towards equalisation, a fact that we must include in strategic thinking now. We must build our careers and invest our wealth to benefit from, not to suffer from, these seismic changes. At RHAM we skew our processes and direct our attention to those aspects in the investment market place that are likely to benefit and this has been a long-time theme of this newsletter.
If the world is changing in this way, if our standards of living are to persistently subside whilst those of the emerging world are to improve, then that should lead to lower inflation here and higher inflation there. The risk in our world is the risk of deflation! The risk of inflation is in the emerging world.
The China effect: consumer price pressure
The Economist reported in its issue dated 1st July 2006 of a very interesting development in retail shopping in China. Under a sub-heading ‘Chinese consumers are ganging up on their retailers’, they explain as follows:
‘On an otherwise quiet Friday afternoon in Guangzhou, a city in southern China, 500 shoppers gather outside a Gome electrical superstore in the downtown district. They arrive en masse at the designated time – June 16th at 4pm – that they had previously agreed online. Several hours later, they emerge clutching boxes, having secured 10-30% discounts on cameras, DVD players and flat-screen televisions.
‘“It was great,” says Fairy Zhang. “We just bought an apartment and this way we can afford nice things for it.”’
What is going on is that Chinese consumers are getting together, they talk to each other online and find that they all wish to buy similar products. Then they all go to one retailer and offer their collective order in exchange for an improved discount. If the retailer refuses, they go to another retailer. Sooner or later, a retailer is going to agree.
In the UK this would be, to some extent, unfair because it is illegal for retailers to collude together to support prices. This makes them vulnerable to this sort of approach and if it gathers momentum it could have an extraordinary impact.
The effect would be a further containment of upward prices. Its effect on businesses generally would be very negative and although consumers might have cheaper televisions, etc., in their homes, the people they work for will be suffering deteriorating business conditions and lower profits which could even lead to the aggressive consumer becoming unemployed.
If everybody makes a lot of money, then everybody makes a lot of money. What goes around, comes around as they say but when the culture becomes one of profit suppression, there is nothing to come around to go around! It is destructive of wealth and is one of the worst features of deflation. We will be watching very closely to see if this idea, which is growing like wild fire in China, has the power to leap across national boundaries, we suspect it has!
The China effect: exchange rate appreciation
Andrew Smithers’ most recent letter discusses China’s currency intervention. The point he makes is that in rapidly growing economies, and China is certainly one of those, they quite naturally have appreciating real exchange rates, unless that is, its interfered with by currency intervention.
That situation will change if either the intervention ends and the nominal exchange rate is allowed to appreciate or if inflation picks up. To make the point, he explains that currency intervention increases domestic debt and because this is difficult to immunise it tends to be monetised, thus leading to increased domestic liquidity.
In the final analysis, like it or not, either through rising domestic inflation or through an adjustment to nominal exchange rate, China’s real exchange rate will appreciate.
Andrew Smithers claims that this has long-term inflationary consequences for the rest of the world. It will be interesting to see if that is so. If it is to happen, we suspect that it will be after a global recession.
The immediate future is likely to be a deflationary consequence of the developed world’s economic policy and global imbalances. Before China’s inflation infects our world, our standards of living need to equalise downwards to their rising standards of living.
Recommended further reading:
You can read more on this issue here: Why China may soon ditch its biggest export – deflation. For more on the high rates of inflation in Asia, read: The hidden risks of investing in Asia.
By John Robson & Andrew Selsby at RH Asset Management Limited, as published in the Onassis Newsletter, a fortnightly newsletter that gives insight into the investment markets.
For more from RHAM, visit https://www.rhasset.co.uk/