For instance, bread baked in the US and China will require the same amount of wheat and wheat will cost around the same. But baker wages will be significantly larger in the US than in China and will result in a much higher cost of the finished product. Therefore, a spike in wheat prices will have a larger impact on the loaf of bread in China than in the US.

Wage inflation: the US and Europe have little wage inflation, as rising unemployment has diminished the already weak bargaining power of the labor force, keeping wages in check. Economic expansion has put significant upward pressure on wages inflation in China (and India as well).

In combination, these two factors were responsible for inflation in high single digits in China, double the rate of inflation in the US.

China is not the cheapest place in the world to manufacture, not anymore. To its benefit, cheaper countries (Singapore, Vietnam etc.) are not big enough to steal a significant amount of capacity and the US in many cases doesn’t have the needed infrastructure to bring manufacturing back. Appreciation in the renminbi and high oil prices (which are driving shipping rates up, placing a significant premium on the distance factor) are making Chinese produced goods even less attractive. Something has to give: either the US will consume less or China will keep prices low to stimulate the demand, swallowing the loss, or a combination of both.

It gets even worse. (I constantly catch myself wanting to say “The story only gets worse,” but unfortunately it does). The US and Europe can cope with energy and food inflation a lot better than China and other developing nations, as we spend a lot less on food and energy as a percent of our income and have a lot more discretionary income. (Just take a look at magazine section in the book store. There's probably something like a fishing magazine for the left-handed fisherman.)

Though the Chinese consume a lot less gasoline than Americans, they don’t have as many cars and don’t drive as much. However, they do have stomachs - they eat.

High energy prices have translated in food inflation that in China runs in the high teens. The average American family spends only 15% of their household budget on food, whereas the Chinese spend 37% . Maybe this is one of the reasons shopping malls are empty. People that pay high gasoline prices but are full don’t riot, but hungry people do. The current situation raises political risk in China and also the chances that government (social) intervention will rise. This also puts in doubt the significant development of a Chinese middle class, at least in the near future.

When I wrote an article for the Financial Times in May discussing risks in stuff stocks (commodities, energy and industrials) I called today’s environment “a global commodity bubble.” I was imprecise. After a conversation with the brilliant Ed Easterling of Crestmont Research (who also wrote “Unexpected Returns” - a must read) and reading a wonderful interview with James Montier by Kate Welling, I’d like use James’ more precise definition of today’s environment: a “global growth expectations” bubble.

After all, it is the supply demand (to a large degree) that was responsible for this unprecedented growth in “stuff”, shifting the mentality of the market into “this time is different” gear. It is not.

In the past “stuff” stocks were cyclical, their margins played a very predictable foxtrot of bouncing together with the whims of the US economy. Today they are behaving if as Google (GOOG) is their middle name – their sales are climbing in double digits, margins keep expanding and now they are called “growth” stocks. They are not. It is just Chinese late stage growth obesity, which has disproportionately impacted the demand for stuff, creating an expectation that the “growth story” will continue forever. Nothing is forever. Starbucks discovered that and so will China. China is likely to have a bright future, but it doesn’t consist of straight-to-the-sky growth trajectories.

Implications: Demand for commodities will decline, while more supply from past investments (there is a significant lag) will be coming to the market – they’ll come crushing down to earth. Companies that make stuff will suffer, their margins are at multi-multi-multi-year highs and margins pendulum will swing the other way to the other extreme. Suddenly they won’t appear to be as cheap. (Take a look at my January Barron’s article in which I discuss the risk in corporate margins and May Financial Times article, which explores China and stuff stocks.)

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