Change in China Hits US Purse

For more than a decade starting in the early 1990s, U.S. inflation declined as low-wage workers in China and other developing nations joined the global economy and produced a tide of cheap goods that washed onto U.S. shores.

The trend made American consumers feel better off and, by restraining the upward crawl of consumer prices, helped enable the Federal Reserve to fuel the U.S. economy with low interest rates.

That epoch appears to be over. Prices of imported goods are climbing, becoming a source of inflationary pressure. A wide variety of common products made abroad, from shoes to auto parts to jewelry, are landing on U.S. docks with higher price tags.

U.S. import prices, excluding oil, rose 8% over the past two years, a historic shift from their downward drift for two decades. The increase is bigger still when including oil, which is up on global demand and Mideast turmoil.

Though the pressures eased a bit in recent weeks as commodity prices retreated, they show signs of becoming a nagging presence as Chinese workers and others in emerging markets win higher wages and also become eager domestic consumers.

The shift is part of a broader change that is reshaping the U.S. economy and its place in the world, with attendant pain as well as benefits. For years, U.S. consumers feasted on cheap imported goods – cheap partly because the Chinese currency was kept undervalued. This bred large U.S. trade deficits.

Most economists agree the U.S. needs to consume fewer goods from abroad and ship out more American-made goods and services. The upward drift in the prices of imported goods is a mechanism that makes that happen.

Currencies play a role. Washington has long pushed China to let its yuan appreciate and to encourage domestic consumption, both of which it has done to varying extents. The yuan is up 28% against the dollar in six years. The weaker dollar helps U.S. exporters, but the stronger yuan and the higher costs within China from domestic demand press upward on the costs of things U.S. shoppers want.

These changes are particularly apparent in apparel and footwear. U.S. consumer prices for apparel fell for 13 of the past 17 years, according to Labor Department data. Now, retailers and manufacturers warn of plans to push up prices on Nike sneakers, Hanes underwear, Abercrombie & Fitch and Polo apparel, Ugg boots and other products when fall lines hit the racks.

The key factor is that cotton prices have surged, driven in part by demand from developing economies. Higher labor costs in Chinese factories, rising transportation costs and the more expensive yuan also are pressuring makers and retailers to push up their prices.

U.S. apparel prices rose 1% in the 12 months through May. The American Apparel and Footwear Association estimates prices for its goods will be up 4% to 6% in the fall from a year earlier.

"The days of watching our product drop in price relative to other retail products have ended," said the association's president, Kevin Burke.

Thus, apparel prices and the cost of other imported goods, rather than helping the Fed control inflation as in the past, could tend to restrain it as the central bank searches for ways to spur a lumbering post-bubble U.S. economy.

Because the economy is still weak, overall inflation is unlikely to surge as it did in the 1970s. Fed officials have been comfortable enough with inflation to hold short-term interest rates near zero. But they are hesitant to take new measures, in part because inflation has ticked up.

The "inflationary impulse" from abroad requires the Fed to be "more wary," Richard Fisher, president of the Federal Reserve Bank of Dallas, said in an interview this month.

The U.S. consumer price index rose 3.6% in the year that ended in May – above the Fed's informal 2% target. This was largely because of gasoline, but pressure is building elsewhere too. Excluding volatile food and gas prices, the index was up 1.5% in May from a year ago, a pickup from increases of less than 1% last year.

"China's disinflationary forces are beginning to wane and more inflationary pressure is building," said Alan Greenspan, the former Fed chairman, who predicted such a shift in his 2007 autobiography. He said his successor, Ben Bernanke, is operating in a more challenging environment than Mr. Greenspan confronted in 19 years running the Fed.

The Chinese supply 78% of the footwear imported into the U.S.; 71% of the ties; 55% of the gloves; roughly 50% of dresses and baby clothing; and 90% of house slippers, according to Commerce Department data.

In contrast to the decades when a flow of Chinese workers from the countryside pushed factory labor costs down, China's workers now are demanding higher wages and better jobs.

They are also emerging as an army of consumers whose shopping puts upward pressure on prices globally. "I can afford even the nice things now," says Shi Yuhan, a 29-year-old telecommunications manager in International Business Machines Corp.'s Beijing office, where she makes more than $4,600 a month.

Ms. Shi hits pricey city shops nearly every week, spending $150 or more at a time. Her new outfits include sundresses from Spanish retailer Zara, a Burberry trench coat and Adidas sneakers with her English name, Rebecca, printed on them. Ms. Shi says she recently negotiated a 30% raise when a competitor tried to poach her, and her income is twice what it was four years ago.

Peter McGrath, a U.S. sourcing consultant for big companies, says Chinese demand is shaping global pricing dynamics.

He sits on the board of directors of Xiniya Fashions, a Chinese retailer with 1,400 shops. He says Chinese consumers pay up to $25 for polo shirts at Xiniya (pronounced Zenya), well above the $15 the same shirts sell for in the U.S.

Even with rebates that Chinese manufacturers get for exporting, that $25 domestic price makes them less willing to accept the price cuts that used to be a standard part of their business, Mr. McGrath says: "They can make more money by selling it to the Chinese market."

Chinese demand is, of course, also pushing up prices of commodities. China consumed 40% of the world's cotton last year, up from 25% a decade earlier, helping cotton prices to more than double since August. Much of this cotton is turned into apparel and exported, so the commodity price rise contributes to a product price rise.

Jiangxi Creator Knitwear Garments Co., in the south-central province of Jiangxi, has 150 employees working 10-hour shifts making underwear and shirts for the Fruit of the Loom brand and others. It pays each worker twice as much today – about $309 a month – as four years ago, and manages to pass about half of its increased cost burden on to foreign buyers, said the factory's manager, Li Jingjian.

"We already give them free room, free meals and cake on their birthdays, but they want more," he said. He has to raise salaries because he is struggling to keep workers amid an emerging labor shortage in China's factories.

More young Chinese are shunning factory work, seeking office jobs requiring less manual labor and work in better paying industries such as electronics. Average earnings for China's city dwellers rose to about $5,500 last year, up 13% from 2009 and 77% from five years earlier, according to China's National Bureau of Statistics.

Another factor is China's one-child policy. "No one wants their only child to work in a factory," said Mr. Li.

China's labor market may tighten further in the years ahead because of demographics. Chinese under age 14 made up 23% of the population a decade ago but now are just 16.6%, which means the portion of the population heading into the work force is shrinking.

Other factors are at play in the wage rise, including an overheating of the Chinese economy, which may prove transitory.

The International Monetary Fund estimates the global work force – counting only people working in export-oriented industries – rose by 532 million people between 1990 and 2005. It will keep rising for the next 40 years, the IMF predicts, but at a slower pace of about 450 million during 15-year stretches.

Gains in productivity – the value of goods or services produced per labor hour – could help offset any slowing in the growth of the global labor force, says Nicholas Lardy, an economist at the Peterson Institute for International Economics in Washington. The IMF estimates productivity in China's export-oriented sectors grew at a 9.3% annual rate from 2000 to 2008, far faster than the 2.3% rate of its trading partners.

In addition, U.S. brands are finding ways to cope with the changing cost landscape. Apparel makers have been shifting production to cheaper locations for several years, a process that has intensified for some recently.

Footwear company Steve Madden Ltd., which is seeing costs rise between 5% and 8% per year, is looking to move production away from the big shoe-producing area of southern China and into northern China, where labor is cheaper, in addition to Mexico. It has already raised prices and has indicated more increases could be coming.

Luxury leather-goods maker Coach Inc. is in the first year of a four-year effort to diversify away from China. "The inflationary pressures are real," Chief Financial Officer Michael Devine said at a recent conference, adding that the ones Coach is most concerned with are "Chinese wages, because they're not going away, and they're only going in one direction."

By no means do all price increases abroad pass through to U.S. consumer prices. Retailers are reluctant to test the willingness of strapped U.S. consumers to accept higher prices.

Retailers can sometimes squeeze other areas, such as marketing, transportation and domestic wages, to avoid having to pass on all of their higher costs from abroad. But with cost pressures building on many fronts, that has become harder.

Bernard Leifer, chief executive of SG Footwear, a New Jersey footwear importer that sells 20 million to 30 million pairs of slippers, sandals, athletic shoes and other footwear a year to U.S. retailers, says many of his 60 suppliers in China have complained about labor shortages. Higher prices for leather, plastic and freight, plus the appreciating Chinese currency, all lead to more dollars spent getting goods produced and sent to the U.S.

Mr. Leifer says he now has to pay about $2,100 to ship a 40-foot container filled with shoes to the West Coast, up from $1,000 three years ago. That has added about 25 cents to the cost of every $3 pair of slippers he distributes.

He says shoe prices had been tumbling ever since he set up shop in Hong Kong in 1988, but not any more. He estimates that U.S. retail slipper prices will be up 10% to 15% this fall from a year before.

"There's been a shift in who is holding the cards," Mr. Leifer says. "It used to be that the retailers would demand lower prices. Vendors like us would demand lower prices from the factories. And the factories would generally acquiesce. The whole thing has now flipped. The bottom line is the American consumer is going to end up paying more."