Japan Keizai Series -  Changing Cost Structure of Chinese Manufacturing

I have written the timeline in a provocative way so that westerns who don't have a good sense of China's history might be able to appreciate why there is still a bit of hidden resentment within the Chinese government regarding there dealing with the west. 

Timeline

• Late 1930s - America, using British bases in Burma, conducts what was then a clandestine aerial bombing of Japanese positions in China using decommissioned USA military aircraft and trained US military personnel on furlough or medical leave.
• Late 1940s - America backs the Nationalist's military aspiration in China and loses.
• Late 1950s - America fight the Chinese directly in Korea, but calls the war "the Korean War"
• Late 1960s - America continues is cold war with China and indirectly in Vietnam. 
• 1972 - Nixon goes to China.  An amazing event as Nixon was a fierce anti-communist.  The event is summarize in the phrase "Only Nixon could go to China" - so he did without telling anyone beforehand.  Truly amazing.  Nixon in his speech acknowledged 22 years of open hostility between the US and China, but of course we know it was long. 
• 1979 - U.S. broke off diplomatic relations with Taiwan and established full diplomatic relations with the China.
• 1986 - China's request to be readmitted under under GATT (Governing Agreement Trades and Tariffs)
• 1997 - Hong Kong Transition.
• 1999 - Just before China enter the WTO - good reference Apparel - China Pre-WTO.pdf
• 2001 - China joins the World Trade Organization.
• 2006 - America begins multiyear effort to force China to devalue the Yuan - which at had been "fixed in the 8.25 per dollar range for over ten years. 
• 2009 - Yuan relative to the nominal dollar declines 17.5% from 2006 to 2009,  but only decline 5% relative to the yen. 

Japan Specific Issues

• Japanese yen was strengthening in a big was up this 1995.  It then dropped significantly.
• Since 1997, on a nominal basis, the Yen has traded in a relatively narrow band.
• However, since 2000, because of inflation effect, the purchases power of the yen in China has actually erode 20% in terms of Yuan.
• 2009 was a year the yen strengthen.

Implication of Rates.

• America will likely continue to pressure the Chinese to devalue it currency relative to the dollar.
• This will make Chinese imported good more expensive in the US and help the US with it tremendous current account deficit, which has decline but is still an unsustainably high levels.
• China will probably continue in its effort to devalue its currency.  However, inflation in USA is now more than in China, which changes the basis toward the Dollar weakening against the Yuan. (both nominally and real))
• Nominal Rates.  The Japanese yen could trade nominally in the same trading range.  However, I believe the 10 year outlook for purchasing power of the Yuan to be more last the last 10 year - namely a 20% decrease in the purchase power of the Yen.

Implications for Manufacturers in and Importers from China.

• Conceptually, all else being equal, the price of products manufactured in China will like rise. 
• Unless retailer can pass along these cost, gross an operating margins will likely decrease.

Risk Management.

• One important tenet in international business risk management it to match the source currency for the repayment of debt with the that of the debt.  In simple terms, if you are going to build plants in China that sell products in Japan, make sure you borrow yen.  That way if the yen weakens in a significant way, you don't get left with lots of Yuan debt that is difficult to repay. 
• Of course borrowing Yen secured by assets valued in Yuan also has it unique risks.  In particularly, foreign currently translation gains / losses is magnified.
• The good news is that most companies dealing with china don't build plants because they production is sourced and contracted. 
• A second important tenant in international business is more of a strategic nature - manufacturing strategy.  For example if I told you for certain that the cost of  importing Chinese products were going to increase 20% over the next year relative to Japanese produced products, strategically you might say - to meet Japanese demand, lets gear up some Japanese manufacturing capabilities which are scalable so we are in position should this occur.   Easier said than done, but one gets the idea

"Gaikai"  Manufacturing Strategy for the Japanese Market

Japan is like most consumer markets except for one thing - as a whole, they have the highest quality expectation of any market in the world.  Other than that, a manufacturing strategy comedown to balancing:

• Price.
• Quality, control and procedure issues.
• Lead time and logistical issues.
• Labor and ethical concerns.
• Financing and cash flow concerns.

China has compelling low labor costs and the coastal region good convenience logics.  The local infrastructure of the following area supports low-cost efficient manufacturing processes.

• Pearl river delta region of Gaungdong, including Hongkong and Macau.
• Yangtze river delta region including Shanghai, Zhejiang, and southern Jiangsu provinces.
• Fuijian coastal region across from Taiwan
• Bejing-Tainjin region
• Qingdo and Dalian

MORE LATER.