China's boom too good to last

Welding, China-style  how long can this sort of thing keep
going?

Welding, China-style how long can this sort of thing keep going?
Photo: Reuters

 
Marcus Padley
June 23, 2007

LET me ask you. When did you last see the label "Made in Taiwan"? Anyone in Generations A-W will get the point immediately.

There are certain things about the current boom that will not last. One of them is cheap Chinese labour. Millions of dopey folk with mud on their boots wandering into the cities, eyes agog. They are being put to use and their use is putting tens of per cent into manufacturing company margins across the western world.

Those margins are turning up in share prices. And with so many naive people ready to be exploited, it's no wonder inflation isn't spiralling as it should be in China. The Chinese consumer isn't getting paid enough to push prices.

But it won't last. Nothing this good ever does. It didn't in Taiwan. Their citizens went from naivety to sophistication and beyond. They became wealthy.

In China the same thing will happen. The dopey country folk will become a savvy workforce. They will sense their exploitation; they will demand more. Their costs will rise and it will all come to an end. In the past year Chinese labour costs have risen 10 per cent. It's the beginning of the end.

As they mature, the Chinese will run into a host of social problems. The bedrock of their industrialisation - cheap labour - will thrash and become unreliable. As it does the western profit margins will fall, the growth will dissipate and the potential will diminish. In its place will be left a nation trying to sort itself out.

No more will the world be flooded with cheap goods. On top of this the metal and commodity prices will feed through to finished goods prices and the CPI numbers. The oil price and energy prices will also be squeezed. It will all come home to roost in higher inflation and that means higher interest rates and falling bond markets.

The other thing that will not last is the Asian investment in US bond markets and US assets. Their participation in US Treasury auctions is already backing off. They have absurd reserves exposed to one currency and one asset class. With the potential in Asia they'll start to invest closer to home.

The US is not going to lead us into infinity. Their balance sheet is weak, their profit and loss is unprepared for the costs of the baby boomers and their credit card bill is enormous. Their currency is threatened. It just makes sense for the Asian support of the bond market to weaken and as it does the US bond yields will no longer be held artificially down. Another reason for them to rise.

I remember reading a US study which concluded that when a stock jumped or fell sharply on a price-sensitive announcement it tended to trend in that same direction for the next nine days. In other words, you could sell or buy into the trend on the first trade after a price gap and still make money.

In the same way, the recent big jump in bond yields is a sign. It is the sign of a trend. That's why the market got so upset about it. But unlike the concerns about the Chinese stockmarket, the bond yield concerns are going to stay, develop and become a much bigger influence.

Look at any of the major long bond yield charts. They are all on the rise, and not just in the last couple of weeks. They have been on their way up since 2003. The message from the recent flick up is that the trend is going to accelerate.

So what do you do if inflation and interest rates are on the way up? Two things:

Lock in the mortgage at fixed rates for the next five years.

Make the most of this golden window of opportunity while it lasts.

Now is not the time to be cautious about equity markets. There is plenty of play before the problems roost. And anyway, all this is global stuff. Australia will be a great market for many years and we'll list the reasons why in the Marcus Today newsletter this week.

Marcus Padley is a stockbroker and the author of the daily stockmarket newsletter Marcus Today. For a free trial, go to www.marcustoday.com.au