The China Inflation Problem and Its Impact For Markets

Elsewhere in the world, China’s government continues to walk a very thin line. China’s GDP is largely created by funneling easy credit (total credit is now at 200% of GDP) into infrastructure projects (a record 49% of China’s GDP is in investment)… the cost of this money pumping and incessant investment is higher inflation:

In China, consumers pay nearly $1 more for a latte at Starbucks than their U.S. counterparts. A Cadillac Escalade Hybrid Base 6.0 costs $229,000 in China, compared to just over $73,000 in the U.S.

Welcome to China's modern retail world, where the price of many goods is far higher than in many other countries, a disparity that is all the more stark considering the income differences. A basic iPad 2 is priced at $488 in China, where average per capita income is around $7,500. The same tablet is $399 in the U.S., where average per capita personal income totals $42,693.

Clothing and other apparel is on average 70% more expensive for consumers in China than in the U.S., according to data from SmithStreet, which compared the prices of 500 items of 50 brands in both countries.

http://online.wsj.com/news/articles/SB10001424127887323932604579052973988936230

However, the reality of higher inflation won’t show up in China’s inflation data (which clocks in at an absurdly low 3%). However, you can see clear signs of this in China’s civil unrest: you don’t get wage and labor strikes for nothing. Workers protest for higher wages because they cannot afford increased costs of living.

In the three months from June to August 2013, China’s Labor Board recorded a total of 183 incidents on our Strike Map, up seven percent from the previous three months, and more than double the 89 incidents recorded from June to August in 2012.* In July alone, we recorded 78 incidents, with another 67 in August…

In Guangdong, for example, police detained 14 workers from Xinrongxin Kitchen Appliance in Shunde district on 27 August after they took to the streets demanding a total of four million yuan in wage arrears…

One trend of particular note in the strike map data is the increasing number of disputes in larger enterprises, those with 100 to 1000 employees. The proportion jumped from 35 percent in the months of June, July and August 2012 to 60 percent in the same period this year. In addition we noted five strikes involving more than a thousand people. In the manufacturing hub of Dongguan, for example, more than a thousand women workers staged a strike against wage cuts on 14 June and blocked the roads outside Hop Lun, a Swedish-owned garment company.

http://www.clb.org.hk/en/content/china’s-workers-turn-heat-summer-protest

Thus we are in a world in which Chinese officials must manage expectations, trying to convince investors that they won’t let inflation get out of control… but won’t crash the financial system either.

China's central bank added fuel to fears on Thursday it was clamping down on inflation risks as it allowed cash to drain from the financial system for a second straight week, sparking a jump in short-term rates.

The move by the People's Bank of China (PBOC) happened as Beijing stepped up its efforts to counter surging property prices in the capital in an attempt to calm rising discontent over the city's record-high home prices.

China also widened the funding options for local governments and property companies by giving them access to the interbank bond market to finance affordable housing, a priority of Chinese leaders, sources told IFR, a Thomson Reuters publication.

Housing data this week has raised fresh concerns about property bubbles in some major cities, which could add to consumer inflation – already at a seven-month high – and add to criticism that home prices are increasingly out of reach of ordinary Chinese.

http://www.reuters.com/article/2013/10/24/us-china-economy-idUSBRE99N07P20131024

I was bearish on China before, but they appear to have successfully navigated their “liquidity crisis” from earlier this year. But inflation is becoming a real problem there. The key issue will be how a slowdown in China impacts the markets.

Mark this as a major theme for 2014.

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Phoenix Capital Research