There exists a widespread belief that Americans “don’t make anything anymore,” and that an enormous proportion of what Americans consume comes from China.
This premise has led many to speculate that if the U.S. dollar (USD) devalues relative to the Yuan that the inflationary consequences in the U.S. would be grave. Other analysts worry that due to the increasing dependence of the U.S. economy on Chinese production that rising inflation in China due to rising labor, material and food costs will result in increased inflation in the U.S.
This issue has important implications for the American economy generally since higher prices paid for goods and services – for whatever reason – lower Americans’ real wages and diminish their living standards. Such inflation would also reduce real GDP. Furthermore, this issue has implication for the value of U.S. Treasury securities and other fixed income investments as higher expectations of future inflation would lead to higher interest rates demanded by investors.
HOW MUCH OF WHAT AMERICANS CONSUME MADE IN CHINA?
How much of what Americans consume made in China? According to a recent thorough study, the results of which were partially released by Galina Hale and Bart Hobijn of the San Francisco Fed, the answer is: very little.
One of the keys to understanding why is to realize that despite the increase in globalization, the U.S. economy is relatively self-sufficient. In fact, fully 88.5% of all goods and services are “Made in the USA.”
Much of the self-sufficiency of the U.S. economy is due to the fact that services comprise almost 70% of the U.S. economy and Americans produce the overwhelming proportion of those services.
In total, only 11.5% of Personal Consumption Expenditure (PCE) consumer goods and services are produced abroad.
Only 2.7% of consumer goods and services consumed by Americans are “Made in China.”
However, even that 2.7% figure greatly exaggerates the importance of Chinese goods and services to the overall U.S. economy. It is critical to understand that not all of that 2.7% cited above is actually made in China. Most of the value of Chinese imported goods consists of transportation, distribution, marketing, margins and other costs added in the U.S.
Thus, when this “Made in USA” content of Chinese imported consumer goods is stripped out, it turns out that only 1.2% of what Americans consume is made in China. Fifty-five percent of “Made in China” is actually “Made in the USA.”
To go even further, much of that 1.2% is not really “Made In China” either. Much of the import costs of Chinese goods actually consist of value added from component parts and/or services from other countries – including the USA.
For example, in a widely cited study, Xing and Detert examine the production costs of an Apple (AAPL) iPhone. In 2009, it cost roughly $179 to produce an iPhone in China, which sold in the United States for about $500. As a result, $179 of the U.S. retail cost was "Made In China" imported content.
However, only $6.50 of the $179 was actually attributable to assembly costs in China. The other $172.50 reflected costs of parts produced in other countries -- including $10.75 for components made in the United States. In this example, an Apple iPhone that is accounted for in the import accounts as "Made In China" is actually much more "Made in the USA" than "Made in China. That is true of both the manufacturing and service content of an iPhone.
The bottom line is that much of the 1.2% cited in the table above is not made in China but “Made Outside of China,” including the USA.
INCORPORATING INTERMEDIATE GOODS
The analysis thus far only applies to the import content of consumer goods. However, if intermediate goods are added in order to make a total accounting of the import content of American consumption, the total share of consumer spending accounted for by the cost of Chinese goods rises by 0.7%. This means that a grand total of 1.9% of all of the goods and services that Americans consume is “Made in China” And again, as explained before even some of this 1.9% is actually made in the USA and other places.
The following chart graphically illustrates the relative unimportance of Chinese imported goods and services in the context of the total U.S. economy. Again, due to the fact that much of the 1.9% cited is actually “Made in the USA” and elsewhere, the 1.9% figure exaggerates the Chinese content in Chinese imports. (Having said that, the Chinese content in non-Chinese imports could make this third-order factor a wash).
Let us assume that the Chinese Yuan were to appreciate 5% per annum versus the USD in the next three years. Furthermore, let us assume that Chinese inflation in the next three years rises by 7% per annum and that Chinese producers were able to pass along 5% of those cost increases to U.S. consumers every year.
Under this example, the cost of Chinese imports would rise by 10% per annum for the next three years.
Now, let us assume that the Chinese did not lose any market share as a result of such cost increases. This is a ridiculously unrealistic assumption. However, let us assume so, just for the sake of argument.
Given the total share of Chinese made goods and services (1.9%) in the total value of all goods and services consumed by American consumers, the U.S. Personal Consumption Expenditure Price Index (PCEPI) (and CPI) could be expected to increase by roughly 0.19% per annum for the next three years. That is a rounding error!
Thus, fears of U.S. inflation caused by a devaluation of the USD relative to the Yuan and/or due to rising inflation in China, are completely unjustified.
The issue of Chinese imported inflation is virtually of nil importance to the bond market (^TNX, ^TYX). And its importance to the overall U.S. economy and stock market (^SPX, ^DJIA, ^NDX) is very modest indeed.