A major economic effect of the debate over China outsourcing which has not been mentioned is that it has helped US companies boost their margins, and most of all, the American economy, keep prices stable even though money supply has grown. Many of these US corporate profits have found their way into hedge funds, fueling a liquidity bubble.
Economics teaches us that the more money is issued by a central bank, the cheaper it becomes. In this respect, a currency is just like any other product or commodity; the more available the less value it has unless it is offset by an increase in demand.
In today’s US economy, money is not created just by the central bank, it is also created with credit instruments, such as credit cards, which shift the responsibility for credit creation to the individual and away from the banks. When the economy is growing and everything is going fine, no problem. But when times change, such as with the subprime mortgage problems in the US, things can begin to turn ugly quickly.
The global economy in general, and the US market in particular, have gotten a free pass from price inflation, largely because of China outsourcing. Chinese suppliers, and the Chinese government, with their seemingly limitless willingness to take devaluing US dollars, and to hold their manufactured products’ FOB prices, have in fact protected US consumers from price inflation.
How do we know?
Let’s take a look at the exchange rate between the euro and US dollar, two major currencies which are freely traded on currency markets with a minimum of government interference, unlike the RMB, which is traded within a government-set band.
Google Finance tells us that the euro has risen 22.09% against the US dollar since Sept. 2003. This means that if the RMB was allowed to rise, as many in the US congress and media have requested, then Chinese product prices would rise considerably, hitting American consumers in the pocketbook at a time when many are already facing a credit pinch. Without a doubt, many more Americans would be pushed into bankruptcy by such a move.
When price inflation hits, it usually first manifests itself in commodity prices, such as oil and metals. These are the raw materials of manufacture, which are processed into other materials which find their way into the supply chain. And now, the US is facing increased competition for these commodities, mostly from China and India, resulting in higher prices. For this reason, Jim Rogers, who has been long on China for ages, believes that commodities are a sure-fire investment, going so far as to write a book, “Hot Commodities, How Anyone Can Invest Profitably In the World’s Best Market”, on the subject. Normally, these higher commodity prices would be passed down the chain, who would eventually pass it down to consumers.
US importers have been lucky keeping prices in check by pressuring their China suppliers on price, and sometimes by switching to other suppliers. Most of these Chinese suppliers are operating on very thin margins, since they face higher material costs, and now in China, labor shortages as well.
Facing these pressures and falling margins, it is common for Chinese manufacturers to lure in new suppliers with low unit prices to secure the customer, then to either 1) gradually raise prices or if that fails, 2) to cut back on quality.
So far, American importers have been able to hold the ground on prices by pressuring their suppliers, and sometimes by switching to new suppliers. Common sense tells us that manufacturers cannot indefinitely manufacture at a loss; something has to give. This is the economic context within which everyone is operating.
When that happens, prices will rise and inflation will raise its ugly head again.