Inflation has firms rethinking Made in China

By Emily Kaiser and Nicole Maestri - Analysis

WASHINGTON/NEW YORK (Reuters) - From southeast China to the California ports, a seemingly endless fleet of container ships has carried more and more cut-price merchandise to bargain-hungry U.S. consumers.

But the flow is now slowing as soaring costs for food, fuel and a host of other raw materials drive up prices inside China, making its exports more expensive too.

The result is higher prices at U.S. stores like Wal-Mart and Target that have increasingly filled their shelves with Chinese-made goods. It may also mean thinner profit margins for a wide swathe of Corporate America, which for years looked to China to drive down costs. And it is beginning to spur a global treasure hunt for the world's next low-cost factory.

The price pressure comes at a delicate time for a U.S. economy still limping through a housing slump now in its third year. Homeowners are feeling poorer, and that has cut into consumer spending, making it harder for companies to raise prices to keep up with inflation.

"It has been China that held down (U.S.) inflation, and I think that's what we're going to lose," said Jerry Hausman, an economics professor at the Massachusetts Institute of Technology who has studied Wal-Mart's impact on inflation.

"Not only is China exporting inflation, but China ... is a reason for a lot of the commodities inflation. They're both cause and effect of the inflation," he said.

As China's fast-growing economy gobbles up a greater portion of the world's resources, pushing up inflation, its export machine is starting to choke on the higher prices. The rest of the world is feeling the pressure as well, most acutely in poor countries that are struggling to feed their populations as food costs climb.

Wages for China's factory workers are rising sharply. Some 50 nations, representing 42 percent of the world's population, currently have inflation rising at double-digit rates, according to Morgan Stanley research.

That helps explain why U.S. import prices posted their biggest three-month rise since 1990 through May. The cost of imports from China were up 4.6 percent for the year ended in May, the largest annual increase since that index was first published in December 2003.

The end result is that each U.S. dollar buys less than it did last year. U.S. Labor Department data shows that it now takes $104.48 to deliver the same buying power as $100 last year. From 2006 to 2007, that change was a more modest $2.85.

THE WAL-MART EFFECT

The China connection is perhaps most visible inside the largest U.S. retail chains. Wal-Mart Stores Inc (WMT.N), Target Corp (TGT.N) and other mega-stores have ramped up imports from China over the past decade, one of their sharpest weapons in the battle for the lowest prices.

Imports now account for nearly 18 percent of the U.S. aggregate demand, up from 10 percent in the late 1980s, U.S. Federal Reserve Vice Chairman Donald Kohn said on Thursday.

The reason is simply price.

In 1997, a dozen men's shirts cost retailers on average $59.15, according to U.S. Commerce Department data analyzed by Sanford Bernstein & Co. In 2007, they cost $42.14. The rise of China as an exporting powerhouse was a big reason behind that fall in retailers' costs.