August 31, 2015
China’s currency devaluation: Good for consumers?
Through a special arrangement, what follows is a summary of an article from Retail Paradox, RSR Research’s weekly analysis on emerging issues facing retailers, presented here for discussion.
What’s going on in China and is it good or bad for consumers (and thus retail)?
First, the panic about the slowing Chinese economy, while a concern in the near term, seems overblown for the long term. The government’s mid-August move to devalue the Yuan amounted to a 3 percent adjustment, although some predict that it will decline 6.5 percent against the dollar by year-end. But the Yuan has appreciated about 50 percent over the last ten years. To many observers, it seems like a "tweak", an attempt by the Chinese to inch the currency a little closer to a market-determined value.
Is the devaluation good or bad for retail in the short term? According to the popular press, it’s good for consumers because Chinese-made products will be a little cheaper. I suppose that may be "a little" true.
Source: Google Finance
If something had a cost-of-goods at $1 and the retailer wanted to maintain a 50 percent margin, that item would have cost the consumer $2.00. If the same item now costs $0.97, the consumer pays $1.94 under the formula. If the retailer keeps the price at $2.00, that’s a bit of a windfall although I expect many will likely adjust prices to maintain a target COG-to-revenue ratio. So, with the proviso that the Chinese currency devaluation remains at 3 percent, it’s probably a push for retail and a "little" better for consumers.
How about in the long term? China is already the world’s top exporter so concerns from India that China is doing an export grab seem a little hyperbolic. A far bigger impact from the devaluation might be the U.S. Federal Reserve holding off on its highly anticipated interest rate adjustment.
But the biggest impact of all in recent days has been the stock market’s hyper-reaction to perceived instability in the Chinese economy. If your retirement accounts are anything like mine, you lost some money, at least on paper.
So much emotion. So few facts. All of this reminds me of a skit by comedian Trevor Noah, Jon Stewart’s replacement, riffing on sports in America:
"It’s the craziest thing I’ve seen in my life. It’s all about statistics! Have you seen sports in America? Non-stop! Guys just come out there … Blah blah! Numbers! Numbers! Stats, stats, stats! You guys know everything, every stat! And then you switch over to your business channels and your economy, and it’s like, ‘well, what’s going on in the economy, Bob?’ ‘Well, nobody knows … but hey! That’s the economy, you never know, right?’"
The bottom line is, "Keep calm, and carry on." Oh, and turn off the financial news network.
Discussion Questions
How do you expect China’s currency devaluation and its less certain economy to affect U.S. retail? Do you see repercussions limited to the stock market or something more?
Poll
BrainTrust
Ryan Mathews
Founder, CEO, Black Monk Consulting
Gene Detroyer
Professor, International Business, Guizhou University of Finance & Economics and University of Sanya, China.
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The biggest impact will be on the stock market. Retailers are more likely to keep the extra margin as profit rather than lower prices to consumers claiming that the changes are too volatile and short-lived to change prices in the marketplace. The volatile stock market, however, may put a damper on consumer confidence and spending.
Brian has alluded to the key issue here. It’s all about market reaction.
One can wax poetic all day long. Sure, U.S. stock market volatility makes it more difficult for the Fed to raise interest rates which benefits consumers so, from that perspective, China’s financial woes help consumers. But if the market collapses and 401Ks start to evaporate the interest rate is sort of a moot point anyway.
The real issue here is; what does the long-term prognosis look like?
What happens, for example, if the price of Chinese exports goes up 3 or 5 percent?
Currencies adjust all the time and those adjustments are often bumpy. But it would be naive to forget that China’s economic future is inexorably linked to ours.
I don’t think consumers will see a thing. Prices on Chinese products will remain cheap. The average consumer doesn’t even know what’s going on in the U.S., let alone China.
As for margins, if CPG companies make more margin I expect they will keep it. Just like when gas prices sky rocketed and CPG companies increased prices. When gas prices came down, prices to the consumer didn’t adjust back downward to reflect the same savings.
Our stock market dropped due to uncertainty. But the fact is that the stock market has been rising for seven years, due in great part to quantitative easing. There will be a correction. The question is, what event will trigger it? Eventually, all the U.S. debt from the “stimulus” will need to be paid down.
As much as pundits are making of the U.S. market swings last week being due to China, I actually don’t think China had that much to do with it. The market flux has far more significant factors like huge fund managers to begin with, that affect the market more than China. For retailing, U.S. consumer sentiment may wane if things get crazy in China, however U.S. spending on imported goods will only continue to increase because of the value perceived.
Over the last year, most major currencies have been devalued by 15 percent or more against the dollar. This move by China is small compared to that. Net, in some cases prices will drop, but the magnitude will be minor.
The impact of China’s currency devaluation on U.S. retail is less about the cost of goods and more about the consumer perception of the future state of the U.S. economy. If the belief is things will be fine then the small difference the devaluation has on the cost goods from China is not significant. If the ripple effect on the Dow convinces people that things are turning for the worse then people will pull back their spending.
The effect of currency valuation against the selling price generally a means to determine market viability for the product or the sourcing. This is why so many companies scramble to eliminate overhead dollars and employees to maintain eroding margins. Currency valuation is the product of burdening variable costs, interest rates and of course the ever telling GDP.
China took on a huge share of world production and is not doing a bad job of fighting against double digit production loses. This is because much of the products still in demand in the weak world economy must continue to source there for hands-on, labor intense component manufacturing. If we want to get a good look at the soft under belly of the world economy Eastern Europe, Russia, the Arab nations and Latin America deserve much more attention from the serious investor.