For those old enough to recall; soon after the second world-war, Japan made copies of well known products. A good example was the then famous RONSON cigarette lighter – everybody smoked, so everybody had one – similar lighters came on the market made in Japan that were labelled R.ONSON. A young Robin Day (now deceased), but then working for the BBC, interviewed, at London Airport, two visiting diplomats from Japan. At point blank he aggressively and rather rudely asked them to justify the process of making shoddy copies of good quality, western manufactured goods and selling them cheaply and unfairly. The diplomats chose not to answer the question, they simply rose and left the room.
That’s how it starts. Emerging nation businesses start by competing at low technical levels, then from there they eventually compete at the highest technical levels. Japan’s story attests to that process and it is one that is now repeating itself in Chindia on a massive scale.
Often the true benefit of low manufacturing costs is not fully passed on to the ultimate consumer but instead it excessively fattens the profits of the so-called platform companies. Modern-day platform companies use cheap labour-based manufacturing opportunities to build fat profits for themselves. These companies cleverly contrive to help Chinese manufactures create jobs so that they, the platform companies, can in turn enjoy bigger profits. The point was very well made recently by GaveKal. That’s a very good business plan, except these fat profits are vulnerable to attack, which brings us to an interesting story that we heard first on the BBC last week.
How cheap became chic
Everybody realises that the profit margin for a pair of Air Jordan trainers made by Nike and sold for $150 a pair, is just huge. It seems that the Steve and Barry’s Sportswear chain of retail stores has got together with Stephon Marbury, a high profile New York Knicks basketball player, and produced a new high performance basketball shoe that he wears in major games that sells at $14.98 a pair. You could buy ten pairs of them for the same price as one pair of Air Jordans. The shoes being sold at this low price have a brand that kids and adults are happy to wear.
This is the opening of Pandora’s box. In the current world of financially stretched consumers, it could lead to a sentiment swing away from overpriced branded products to much lower priced branded products of equal quality – a process that is very deflationary.
It is already the case that expensive surgical operations in America and the UK can be obtained in as good if not better circumstances for much, much less in India. We reported a few issues ago, that American companies who bear the cost of their own healthcare benefits are already focusing on this opportunity and sending staff who require expensive surgery to India. Even after allowing for the travel costs and other unavoidable expenses, the cost to them is much lower. So far, the American insurance companies haven’t moved, they still use home-grown surgeons to conduct operations. But it must be only a matter of time before specialist insurance products are sold for much lower premiums, providing insurance companies with higher profits based upon utilising Indian private hospitals and surgeons. The income of rich western surgeons is going to come under siege.
Cheap goods threaten developed economies
The developed world’s economy is under serious attack by these developments. Thursday 7th September’s leader in the Financial Times had the headline “Containing the cracks in the world economy”. This was based upon a confidential International Monetary Fund (IMF) report that they had seen. The report examined two risks to the global economy – one on the demand side, the other on the supply side.
The demand side risk is all about a possible sharp US slowdown triggered by its tottering house market. As Richard Russell recently said in one of his daily Dow Theory newsletters, America is 25% of the global economy and US consumers are 70% of the US economy, so any failure of US consumers is a major and deflationary problem for the global economy.
Bizarrely, in our view, the IMF said that the second risk is one of rising inflationary pressures as the world economy runs out of spare capacity and productivity growth slows. The signs of this, the IMF report says, are to be found in high commodity prices, headline inflation above comfort levels and inflationary expectations rising too.
How this will affect pension funds
One simple conclusion they say is that the world is in for a bout of “stagflation” – slow growth and rising inflation. We don’t buy that! The dependence of the global economy upon American consumers and the expanding scale of emerging market economic activity will lead to lower corporate profits. Slowing consumer demand caused by a potentially ravaged US house market, is going to deliver poor, if any, economic growth and deflation. The latest action by the bond vigilantes is, we think, right!
For the pension industry, the black hole into which they are looking could not be deeper nor darker. If asset markets fall, the value of pension funds will largely decline and if bond markets rise, the pension liability cost will increase considerably. Those without resources, dependent upon pensions, will be let down by the system. In the final analysis – pensioners won’t get their full pensions and for some that has already happened. Those who have an opportunity to plan can, by remaining alert and acting correctly, avoid suffering. Instead they can benefit very considerably. The work we do at RHAM is targeted at that.
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/