Chinese Wages Undermine Bond Investors as Prices Accelerate
China, the biggest brake on global inflation for two decades, is embracing wage increases that threaten to erode retailers’ margins and demand for bonds.
Premier Wen Jiabao convenes the annual National People’s Congress March 5, where delegates will approve a five-year plan designed to elevate the role of domestic demand. Part of that strategy is endorsing higher pay, with all 31 Chinese provinces and regions likely to boost their minimum wages in 2011 for the second consecutive year, according to Credit Suisse Group AG.
“When historians go back and describe 2010, the big story will be the massive increase in salaries that will redefine the global manufacturing model and redefine the inflation outlook for the next 10 years,” said Dong Tao, chief economist for non-Japan Asia at Credit Suisse in Hong Kong.
Next Plc (NXT), Britain’s second-biggest retailer, said last month that higher labor costs in China will contribute to an 8 percent increase in its prices in the first and second quarters of 2011. Li & Fung Ltd. (494) of Hong Kong, the biggest supplier to Wal-Mart Stores Inc. (WMT), predicts the price of Chinese exports will increase as much as 15 percent this year as workers earn more.
“The pressures aren’t subsiding,” they’re getting worse, said Randal Konik, an equity analyst at Jefferies & Co. in New York, who identifies luxury leather-handbag maker Coach Inc. (COH) and women’s clothing company Chico’s FAS Inc. (CHS) as having “high exposure to Chinese manufacturing.”
A pay-increase offer in excess of 10 percent wasn’t enough for some workers this month at a Shenzhen factory of Hong Kong-listed Top Form International Ltd. (333) Luo Chenen, a 33-year old migrant worker who sews brassieres for brands including Calvin Klein, said “quite a few” of her colleagues left after the lunar new year for their hometowns and won’t come back because “there are jobs there as well.” A consumer confidence index slid in the fourth quarter on concern about rising prices, Nielsen Co. and statistics bureau researchers said today.
“Right now is not like in the past, when finding a job was difficult,” said Luo, who works in a district of Shenzhen pasted with recruitment notices, some promising “High Pay for Urgent Hire.”
Retailers that source products in China also face a surge in the price of cotton that has undermined profit margins. Cotton futures in New York have more than doubled in the past year, reaching a record $194.55 a pound on Feb. 11, after demand in China, the biggest buyer, surged and flooding damaged crops in Pakistan and Australia.
“China is certainly going to be less of a disinflationary influence on the rest of the world,” said Jay Mueller, who manages about $3 billion at Wells Fargo Capital Management in Milwaukee, adding that the “low” in U.S. bond yields has passed.
Government debt is underperforming stocks as the world economy strengthens in the aftermath of the 2008 financial crisis. Bonds returned 2.07 percent, including reinvested interest, in the year through Feb. 17, according to the Global Sovereign Broad Market Plus Index compiled by Bank of America Merrill Lynch. By comparison, the MSCI World Index of equities soared 19 percent.
At the same time, yields remain lower than in the past. The yield on the 10-year Treasury note, which helps determine rates on everything from corporate bonds to mortgages, is more than 3 percentage points below its average of 7.06 percent since 1980. Globally, the average for sovereign debt is about 2.40 percent, down from about 4 percent in mid-2007.
Former Federal Reserve Chairman Alan Greenspan sees average 10-year Treasury yields soaring to an 8 percent level by 2030. In the shorter term, they may climb to 4.45 percent in the third quarter of 2012, from 3.48 percent in New York yesterday, according to the median forecast in a Bloomberg News survey of 48 analysts this month.
“We’re in the early stages” of Chinese wage growth beginning to mount, and that should lift inflation rates in China and add to pending inflationary pressures in the U.S., Greenspan said in a telephone interview Feb. 17. “It’s a long-term process in train.”
The pay of migrant laborers who fuel China’s export industry soared by 40 percent in 2010, according to calculations by Credit Suisse’s Tao, who has worked as an analyst of China’s economy for almost two decades. It will continue climbing 20 percent to 30 percent in the next three years as Chinese leaders endorse income gains to strengthen domestic demand, he predicts.
Rising Rural Incomes
Shanghai, home of the world’s busiest port, aims to raise its minimum wage at least 10 percent, Mayor Han Zheng told reporters Jan. 21. Tianjin, the port nearest Beijing, may increase by 16 percent this year, state news agency Xinhua reported Jan. 26.
In the countryside, per capita net income jumped 10.9 percent in 2010 to 5,919 yuan ($899), according to a National Bureau of Statistics report last month. The gain exceeded the rise in urban incomes for the first time since 1997.
“Rural migrant workers’ wages are now rising faster than ever before, and we can probably talk about a wage ‘explosion’ here,” Jonathan Anderson, Hong Kong-based chief economist for emerging markets at UBS AG, wrote in a Feb. 3 note. He added that there’s little sign of “exploding” pay elsewhere in China’s labor market.
Officials may take several steps to encourage consumption in the five-year plan, which runs through 2015. They could cut individual income taxes, boost dividend payments from state-owned enterprises and lift deposit interest rates to strengthen household finances, according to Shen Jianguang, chief economist for greater China at Mizuho Securities Asia Ltd. in Hong Kong.
Policy makers also may make changes in the “hukou” household-registration system, according to UBS analysts. The system, which isn’t enforced as stringently as in the past, requires residents to apply to relocate and can impede the free movement of workers.
Such mobility will be more important in the future as China approaches a so-called Lewis turning point, when surplus labor dries up, boosting wages, prices and inflation, according to Credit Suisse and Standard Chartered Plc. Expansion will cause demand for jobs to outstrip supply by 2014, Tao’s team at Credit Suisse calculated in a January report.
Li Wei, a Shanghai-based economist at Standard Chartered, says China already might have hit the Lewis point.
If the country “continues to grow 9 percent to 10 percent per year, there will be a wage spiral” that pushes up prices across the world and puts pressure on bond yields, Li said.
China’s inflation is gathering speed, with consumer prices rising more than the government’s 2011 target of 4 percent in each of the past four months, statistics bureau data showed Feb. 15. The average was 2.2 percent in the decade through 2010.
That soon will feed into inflation elsewhere if recent history repeats itself. China’s consumer price index has in the past decade led by about 20 months shifts in the so-called core U.S. rate for goods, according to data compiled by Societe Generale SA and Bloomberg.
While he predicts inflation in the U.S. will remain benign into next year, Rudy Narvas, a Societe Generale economist in New York, said there is now an “upside” risk, partly because of accelerating Chinese costs. American corporate clients are telling him they may start to “test the waters” to see how much of the pressure they can pass along to customers, he said.
U.S. “inflation has stabilized, and it’s now only a matter of time how soon it moves up,” Narvas said. The Fed’s preferred price gauge, which is tied to consumer spending and strips out food and energy costs, rose at a record-low 0.7 percent annual pace in December.
Central banks such as the European Central Bank and Bank of England are already taking accelerating inflation “very seriously,” Jean-Michel Six, an economist at Standard & Poor’s is Paris, said in a report yesterday. That’s because “instead of being the mere reflection of a single commodity price hike, it reflects a more structural change in international price trends” as Asian labor costs mount.
Japanese deflation also may reverse, said Naokazu Koshimizu, an economist at Nomura Holdings Inc. in Tokyo. Forty percent of Japan’s imports are from China, and foreign competition increasingly influences the price-setting behavior of its businesses, which now are better able to pass along higher input costs given Japan’s stable labor market, he said.
“The emergence of inflationary pressure in China is likely to help ease deflationary pressure in Japan through higher prices of imported consumer goods,” Koshimizu said in a Jan. 11 report. Consumer prices in Japan, excluding fresh food, remained 3.7 percent lower last year than in 1997.
The ability of international retailers to push through full cost increases may be limited because of subdued spending growth in the post-recession U.S. and euro area. Both economies are hobbled by unemployment levels of 9 percent and 10 percent respectively.
The Fed said in its Beige Book regional economic report last month that “most district reports cited comments by both retailers and manufacturers that costs were rising, but indicated that competitive pressures had led to only modest pass-through.”
The biggest source of global inflation pressures for now is a surge in food prices, sparked by droughts from Russia to Argentina to China’s wheat-growing Shandong province and torrential rains in Australia and Canada.
Even if China’s inflation picks up, its influence on the U.S. and euro area may be negligible for now, because Chinese imports account for just 2 percent of these economies’ gross domestic product, said Ethan Harris, head of developed-markets economic research at Bank of America Merrill Lynch in New York. China also is often an assembly point for goods, which puts less pressure on retail prices. In the case of Apple Inc. (AAPL)’s iPhone, Chinese manufacturing costs account for just 1.3 percent of its U.S. sale price, Harris calculated.
“When you see ‘Made in China’ on a product, you think when Chinese wages pick up, inflation goes up elsewhere, but there’s actually a big disconnect,” he said in an interview.
Even so, Coach started a four-year plan Jan. 1 that will move some production out of China and into new markets such as India, Chief Financial Officer Michael Devine said on a Jan. 25 conference call. Lew Frankfort, the New York-based company’s chief executive officer, has said the move will save 150 basis points on gross margins.
Gerry Weber International AG (GWI1), Germany’s second-largest maker of women’s clothing, is increasingly shifting production from China to sites with cheaper labor costs, Chief Executive Officer Gerhard Weber said in a Dec. 7 interview. The company, in Halle, North Rhine-Westphalia, is counting on its ability to move sourcing faster than its rivals, and cited Vietnam, Bangladesh and North Korea as among the new locations.
While Chinese manufacturing wages still are competitive relative to advanced nations, they are undercut by developing Asian neighbors.
Average monthly pay in 2009 for Shenzhen in southern Guangdong province was $235, while Shenyang in northeast China had a mean of $197, both a fraction of Yokohama’s $3,099, Seoul’s $1,220 and Taipei’s $888, according to data compiled by the Japan External Trade Organization. By comparison, monthly manufacturing wages were $100 in Ho Chi Minh City, Vietnam, $148 in Jakarta, Indonesia, and $47 in Dhaka, Bangladesh.
Chico’s also is “working on diversifying” its production base away from China and toward nations including Bangladesh, Sri Lanka and India, with higher Chinese wages a “major factor” behind the shift, said Robert Atkinson, head of investor relations at the Fort Myers, Florida-based company.
“It’s not easy when most of the world is trying to do the same thing,” he said in a telephone interview.
--Sophie Leung, Simon Kennedy. With assistance from Cotten Timberlake in Washington; Chris Burritt in Greensboro, North Carolina; Ilan Kolet in Ottawa; Anthony Feld in New York; Aki Ito in Tokyo and Holger Elfes in Dusseldorf, Germany. Editors: Chris Anstey, Melinda Grenier