Higher Prices? Thank China
China's insatiable hunger for raw goods is starting to sting U.S. consumers
The same global economic forces that have consumers paying higher prices at the gasoline pump may soon have them shelling out more money for their beds, their appliances, and even their food.
In a trend apparent at the start of the year that has accelerated in recent weeks, prices have been soaring for nearly every one of the world's major commodities--the raw materials like metals, grains, and fuels that are essential to making the familiar products of modern life. Until now, consumers remained blissfully unaware of the chaos in the commodities markets, because manufacturers have absorbed the increased cost of doing business rather than raise price tags in auto showrooms and department stores. But the strain is beginning to show, and a few companies have indicated they will ask customers to help share the burden.
Most economists doubt that the run-up in raw materials will lead to widespread inflation. The Federal Reserve clearly has debated the issue but concluded that other factors in the economy--such as relatively high unemployment--will keep the risk of spiraling prices low. Nevertheless, a few analysts see the current rumblings as the beginning of a major shift in the global economy, in which new wealth and continued population growth in Asian countries force U.S. consumers to pay more for limited world resources.
Bill O'Neill, a principal with commodities research firm LOGIC Advisors in New Jersey, can sum up the reason for the commodities upsurge in a single word: China. "The warning signs were out there that Chinese demand for industrial commodities would be strong, but I think it happened quicker than some people thought," he says. With its economy growing at an annual rate of nearly 10 percent, even while adding 11 million per year to its 1.3 billion population, China has been gobbling up raw materials. Markets are merely reflecting the fact that for the first time, the world's most populous country now has a significant number of citizens who can afford cars, meat, and better housing.
A prime example of China's pressure is what has happened to steel: The benchmark hot-rolled-sheet price has jumped 80 percent since last year to $500 a net ton, a 15-year high. "All the raw materials for steelmaking--scrap metal, iron ore, pig iron, coke and coal, lime and dolomite--are being sucked up by China," says Tom Stundza, executive editor of Purchasing magazine, which tracks steel values. "The shipping lanes are full of ships heading in one direction." Nancy Gravatt, spokeswoman for the American Iron and Steel Institute, says that China's steelmaking capacity has increased from 100 million tons annually in 2000 to 250 million tons today. "They're going through their own industrial revolution," she says.
This economic progress a hemisphere away means that U.S. consumers are going to have to start paying more for a good night's sleep. Brian Akchin, a vice president of Fraenkel Co., a home furnishings manufacturer in Baton Rouge, La., says his firm had no choice but to increase the price of its innerspring mattresses recently after swallowing higher costs for steel components for five months. Although he's been paying 20 percent more than he was in October, Akchin says he has no plans to up the retail cost beyond last month's 5 to 6 percent hike. "Business has not been that strong that we want to be raising prices," says Akchin. Sealy, the world's largest mattress manufacturer, said it is weighing a price hike, and Steelcase, the world's top office furniture maker, said last month that it would boost prices soon.
But manufacturers are keenly aware that customers have not seen inflation in durable goods for years, says David MacGregor, an analyst with Longbow Research in Cleveland. Behind the scenes, he says, some makers of washing machines, refrigerators, and other appliances have begun talking higher prices, but retailers are resisting. "Nobody wants to flow it through to the consumer yet," says MacGregor. General Electric has said it hopes that productivity gains will help it avoid heftier price tags.
Because so many manufacturers can similarly make up for high raw materials costs by cutting jobs, slashing pay, and demanding more out of the labor force, analysts at Merrill Lynch recently concluded that "inflation will remain benign" despite the commodities upswing. In stark contrast to the inflationary 1970s, they point out, today only 10 percent of the U.S. workforce is unionized, the lowest percentage in the post-World War II era. And the interest rate gurus agree. In January, while divided on the direction of inflation, the Federal Reserve open market committee opted to keep interest rates low. The consensus was that productivity gains and high unemployment would offset the risk of inflation.
Still, it's hard to believe that China's voracious appetite won't seriously affect the No. 1 consumer nation. With oil, where pump prices move in step with the price of crude oil, consumers already are feeling the impact of China's 30 percent growth in demand last year (it's now the world's No. 2 consumer of petroleum). Whether or not the Organization of Petroleum Exporting Countries holds to the production cuts it made last week, worldwide demand for oil will continue to increase thanks to China, pushing up the cost of all manufacturing and transportation.
Then there's food. China is expanding its livestock herds to meet its citizens' demands for more meat. As a result, the Middle Kingdom has dramatically increased its imports of soybeans, a prime component of cattle feed. China is expected to import 25 million tons of soybeans this year, a 14 percent increase over last year. Soybean prices in the United States, in turn, rose to their highest level in 15 years. Also, while China had been a minor player in the U.S. wheat market, buying just 78,800 metric tons a year ago, over the past year, that figure has ballooned to 1.4 million metric tons. Leading cereal maker Kellogg said last week it is feeling pressure from the grain market and is considering price hikes.
Skinny cows. Most analysts say that domestic food tabs will be only modestly goosed by the run-up in grain. O'Neill of LOGIC Advisors points out that wheat is 5 to 7 percent of the cost of a loaf of bread, so consumers would hardly notice even a significant pass-along in grain cost. Ron Lawson, also of LOGIC Advisors, says that if soybeans become too expensive for U.S. ranchers, they will simply send leaner cattle to market, with little impact on grocery shoppers. "We have so much room to be more efficient that even if raw materials go up at the processor end, the competition that exists today will keep end-user inflation at a minimum," Lawson says.
But a few observers see dire warnings for the future. Lester Brown, agricultural economist and founder of the Earth Policy Institute, thinks the recent increases in grain values are merely "the early tremors before the quake." Environmental degradation in China--loss of irrigation water and rapid urban expansion--has dramatically shrunk the land available for crops. The Gobi desert is growing by 4,000 square miles each year because of these occurrences. China's need for imports will dramatically grow as a result, he argues. And as China turns to the world market, "higher food prices could become a permanent part of the economic landscape," Brown warns.
On the oil front, Stephen Leeb, who manages the MegaTrends fund for U.S. Global Investors, argues that the world is entering a new era in which supply cannot keep up with demand. Although he has no predictions for the next few months (and admits that crude oil prices could drop somewhat, as they did last week), Leeb predicts a dramatic increase over the next five to 10 years. "The stark fact is that the world has very little excess capacity, and it's all in the hands of a very volatile country--Saudi Arabia," says Leeb. In his recent book, The Oil Factor, he predicts $100-a-barrel oil will lead to global inflation. "We have to pray it does so in a gradual fashion," he says.
Commodity upswing
The prices of many raw materials have risen sharply over the past 12 months.
[Chart data are not available.]
[Chart labels]
Soybeans (Per bushel)
March 2003
March 2004
5 6 7 8 9 $10
Crude oil (Per barrel)
March 2003
March 2004
26 28 30 32 34 36 $38
Steel (Per ton, hot-rolled sheet)
March 2003
March 2004
230 280 330 380 430 480 $530
Sources: Energy Information Administration, USDA National Agricultural Statistics Service, Purchasing magazine
Graphic by Rob Cady--USN&WR
This story appears in the April 12, 2004 print edition of U.S. News & World Report.