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Jubak's Journal
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8 ways China affects all our lives now
China already is impacting our lives in major ways now -- from the shuttering of blue jeans plants in Texas to the lowering of our mortgage rates. Here are 8 key areas where the influence is large and growing.
By Jim Jubak
Just walk into the toy section of a Wal-Mart if you want proof that Chinas emergence as a global economic power reaches deep into the lives of all of us here in the United States.
China manufactures about 80% of all the toys sold in the United States, even such iconic products as Ohio Arts Etch A Sketch. In 2001, Ohio Art moved production of Etch A Sketch (which it playfully likes to claim as the worlds first laptop) to Shenzhen near Hong Kong from Bryan, Ohio, where the toy had been made for 40 years.
Count the ways just this one example ripples across our economy:- Manufacturing jobs that paid $9 an hour in Bryan are shipped to China where workers at the new manufacturing plant make 24 cents an hour.
- Toys are cheaper at Wal-Mart, where an Etch A Sketch sells for just $9.99. (Thats pretty remarkable for a toy that sold for an inflation-adjusted $23.99 in 2004 dollars when it was first introduced.)
- More pressure on the pensions and health benefits of U.S. workers since most of the workers theyre competing with dont get those costly perks.
OK. OK. Youre familiar with the lost-job story by now. But the China syndrome -- which Im using as shorthand for all the changes to the global economy brought about by the entry of China, India and other rapidly-growing economies onto the world stage -- are by no means limited to job losses and lower prices at Wal-Mart. They extend far deeper into our lives than most of us realize. And, for better or worse, China will influence even more of life here in the years ahead.
Let me dust off my trusty crystal ball and sketch in eight ways that China matters -- or will matter -- for our everyday lives.
China has helped produce lower mortgage rates. Chinas influence in the U.S. bond market extends far beyond its own purchases of U.S. Treasuries and whats called agency paper. (By this, I mean the bonds issued by Fannie Mae (FNM, news, msgs) and the other government agencies that dominate the market for mortgage-backed securities.)
Price competition from Chinese manufacturers, who buy and sell in a yuan pegged to the U.S. dollar, kept the Japanese and other central banks on a Treasury buying spree to keep the value of the yen, the South Korean won and other Asian currencies from climbing to the point that these countries lost export share to Chinese companies.
In the 12 months that ended in April, foreign central banks bought $260 billion in U.S. Treasuries and agency paper, leaving the Federal Reserves purchases of $33 billion trailing in the dust. Its hard to gauge the total effect of all that foreign buying on U.S. bond yields, but the buying has probably kept the yield on the U.S. 10-year Treasury note down by somewhere between a half and a whole percentage point. And we have all benefited because the rates on most U.S. mortgages are linked to the yield of the 10-year note.
Of course, now that the Japanese look like theyre temporarily out of the business of supporting the yen, the effect works in reverse. In the short run, its another force putting downward pressure on Treasury prices -- and upward pressure on interest rates. In the long term, though, foreign buying of Treasuries will keep U.S. interest rates lower than they would be if the Treasury market had to depend on just U.S. buyers.
Chinese competition has cut inflation in manufactured goods and brought more inflation in commodity prices. Its not just the lower costs that Ohio Art, Levi Strauss (which stopped making jeans in the United States this year when it moved production from two San Antonio plants) or Hewlett Packard (HPQ, news, msgs) get by moving production to China that have reduced inflation here in the United States. Competition with cheaper foreign goods and lower-cost foreign factories has made it just about impossible for companies to raise prices on manufactured goods sold in the United States. A price hike, even a modest one, has been almost a guarantee that the company would lose market share.
The deflation in manufactured goods, however, has been offset by inflation in commodity prices in food and energy prices. So, while the Consumer Price Index rose 1.6% year-over-year in March, food climbed by 3.2%. The cause? Competition in the markets from Chinese buyers for everything from soybean oil to nickel.
Chinese demand has meant higher energy prices, especially at the gas pump. The energy inflation being exported from China is a special case just because it is so extreme. Wall Street broke out in a sweat after the March inflation numbers because inflation over the last three months has revved up. If you annualize the change in the CPI during the last three months, inflation is running at a rate of 5.1%. But that shrinks into insignificance compared with energy inflation. It has run at an annualized 38% rate over the same period. I certainly dont expect energy prices to keep climbing at that rate, but I do expect inflation in the sector to stay well above inflation for the economy as a whole. Energy inflation was, after all, 6.9% in 2003. Just think about this one example: Chinese consumers bought 2 million new cars in 2003. By 2014, projections put 100 million cars on Chinas roads.
China has resurrected 19th century imperialism with a twist. In the bad old days, imperial powers turned less powerful regions into colonies. From the colonies, they then extracted raw materials and sold manufactured goods on their own very favorable terms of trade. In the 21st century, dont expect a return to such naked grabs of real estate; the industrial economies will instead fight a much more subtle economic battle to lock up critical commodities.
You already can see this in northern Asia where China and Japan have fought a bare-knuckled brawl over the route of an oil pipeline from Russias Siberian fields. China thought it had a done deal to send the pipeline to Daqing in the heart of Chinas oil producing region. But Japan now seems to have the inside track for a route that terminates in the Pacific port of Nakhodka -- and bypasses Chinas oil fields.
The United States has one key edge in this global competition since it is the sole industrial power with the ability to project military force just about anywhere on the globe. A key question is how often the United States will choose to employ that edge in the competition for resources?
China has helped generate the explosive growth in for-profit education. When the job market gets tough, the tough go back to school. And the toughest go back to school while theyre still employed. UBS Financial Services calculates that about 17 million adults in the United States fit this bill. Its this population, fearful of the changes now sweeping through the economy, who are fueling the boom in for-profit education. UBS projects that revenue at a company such as Career Education (CECO, news, msgs) will grow at a rate of 55% a year over the next five years. Expect the traditional colleges and universities to react to this market shift with increasing numbers of non-traditional, post-degree programs for working adults. The college campus will be a very different place, if it exists at all in its traditional form, in a decade.
China will accelerate development of the next generation of the Internet. The new global economic system assumes subassemblies are made in Malaysia, assembled in China for a Japanese company and, finally, sold to U.S. consumers through Wal-Mart.
The flow only works if what is in reality a single company operating different functional divisions under different ownerships can communicate vast quantities of information in real time. The Internet as we now know it is showing signs of stress and overloading. So, companies operating within this global economic framework will push for the Internets next generation, now in its initial stages of construction, to reach commercially valuable stability as quickly as possible.
China is increasing the importance of logistics to business. These global virtual companies dont just have a need to communicate vast amounts of data. They also must be able to track an immense number of real objects in varying states of market readiness.
Its hard enough to manage a supply chain if all you have to do is walk from one end of the plant to the other to see if you have enough left-door arm rests to keep your SUV production line rolling at full speed. Now imagine that the left-door arm rests are coming from an auto-interiors assembler in Canada as part of an interior unit that itself relies on parts makers in Shanghai, Detroit, Stuttgart and Malaysia.
That logistics nightmare will require new systems for tagging and tracking in real time; these systems are just now emerging with radio-frequency identification tags and global satellite positioning systems.
China may well make bottlenecks a way of life. In an ideal world, the combination of high-technology logistical systems with real-time-data sharing over the Internet would result in part A arriving at site B just in time to meet up with assembly C. The real world, however, is messier than that. Railroad cars wind up in the wrong place or just dont exist in sufficient numbers. An unexpected spike in demand meets up with health scares like SARS, and a key factory shuts down just at the worst time. I can see three results:- Massive and rapid swings in the prices of limiting inputs such as railroad cars or ocean freighters.
- A sharp spike in consumer dissatisfaction as we hear more and more often, Im sorry thats not in stock.
- A rapid differentiation between companies that actually master this system (and gain lots of new customers and make lots of money) and those that dont (and go out of business).
Thats about as far ahead as my crystal ball can see. And as with any exercise in imaginative projection, Im sure that any one reader will disagree with some or all of these potential trends.
But I think we can agree on one thing: the economic phenomenon that we call China will reshape daily life in the United States over the next decade in ways that weve just begun to think about.
Changes to Jubak's Picks
Sell BorgWarner
I think Im spitting into the wind with BorgWarner (BWA, news, msgs), and its time to sell before a modest loss becomes something truly damaging.
Car sales have shown signs of slowing under the impact of higher gas prices. Inventory at General Motors (GM, news, msgs) of its gas-guzzling Cadillac Escalade, for example, now stands at 125 days of sales, about twice the target level. Wall Street fears that this is just a sign of things to come as gas prices stay high and interest rates start to move up. This is forcing automakers either to sweeten their financing deals for buyers or face slowing sales.
Im selling BorgWarner out of Jubaks Picks with a loss of 11% since I added it to the portfolio on Jan. 13, 2004. (Full disclosure: I will be selling my personal position in BorgWarner three days after this column is posted.)
New developments on past columns
3 guilt-free steps to making money overseas
Canadian Pacific (CP, news, msgs) has faced tough going since I named it as one of my top ways to go global without guilt. A bad avalanche that the company says was the worst in eight years, plus severe weather, hit freight volumes in January and cost the company about 10 cents a share.
Volumes and revenue, however, picked up in March with ton-miles climbing 17%. On April 27, Canadian Pacific reported first-quarter income of 18 cents a share, five cents a share below Wall Street estimates. And with key freight trends looking like theyve turned the corner, Im keeping the stock in Jubaks Picks. As of May 11, Im raising my target price to $32 a share by stretching out the schedule to December 2004.
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: BorgWarner. He does not own short positions in any stock mentioned in this column.
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