As markets get whipsawed by news coming out of Europe and the Far East, we often get asked by our clients, “How does this affect me?” Last week, my colleague, Peter Churchill-Smith wrote about the effect that Greece can have on business owners in Canada. This week, we turn our attention to China.
As investment managers, we have no shortage of pundits willing to tell us their views on the economic landscape. One of the advantages of working with entrepreneurs is being able to speak to people who are on the ground and experiencing firsthand the massive build up in production and pent up demand for goods in China.
David Colfer, Vice-President Sales and Marketing of Coranco Corporation, a company that has been licensing, sourcing, importing and distributing premium quality cookware into Canada for the past 40 years, recently came back from China and spoke with me about the effect of China’s emergence from recession is having on his company.
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China’s recession was GDP growth of 6%. The country needs to grow at 8% simply to keep pace with its population growth. GDP is now growing at nearly 11% per year and industrial production has recovered to pre-recessionary levels, leading the world out of recession. All of this occurred despite the fact that many factories were shuttered during the recession, taking capacity out of the system.
“During the recession, we saw a lot of factories being closed. Now, with excess capacity completely used up, the problem is worse and it’s difficult to schedule production,” says Colfer. “There are even labour shortages in the factories because workers didn’t return to the factories after the Chinese New Year.”
A centralized government means China has the ability to affect massive fiscal policy with almost no lag effect. A decision to stop subsidizing the cost of power to heavy industrial users goes into effect almost immediately, which is in turn passed on right away to the purchasers of goods. Combined with power shortages that are closing many factories for one day a week, again puts pricing pressure on the goods being manufactured. China is “ticking at a pace that is unheard of,” says Colfer. “Capacity shortages, shutdowns and labour shortages are affecting our ability to get goods produced and increasing the cost to do so.”
As its economy matures, Chinese policy has been to increase domestic demand for its own goods, rather than simply being an exporter to the world. “One of the things I noticed was that many Chinese consumers were receiving rebates on Chinese produced goods of up to 30% of the cost. I’ve never seen retail sales like what is happening right now,” indicates Colfer.
With an increasing middle class demanding the luxuries of their newfound economic status, production capability seemingly maxed out and raw material prices rising, the pressure on prices to importers like David Colfer and ultimately any manufacturer, importer or consumer of goods around the world will be incredible.
The lesson is this: whatever you consume today, part of it is directly or indirectly sourced from China. With the cost of goods rising, manufacturers, importers and retailers of goods are going to have to pass these costs on to their customers. And that’s going to mean inflationary pressure. Whether that inflation becomes real, or not, depends largely on Chinese policy going forward. Will they attempt to reign in growth? Or continue on the path of accelerated expansion. It will be interesting to watch the dynamics and undoubtedly much will be written before we get to the end of the story.
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