China, Fed policies forcing retail prices up

( Reuter )- At a time when U.S. consumers are feeling pinched and looking for bargains, policies of the U.S. Federal Reserve and the Chinese government will make it hard for U.S. retailers to keep a lid on their prices.

Retailers complained in unison of higher costs for materials, labor and transportation in their fourth-quarter earnings reports. Since most clothes, shoes, electronics and toys are manufactured overseas, the doggedly weak U.S. dollar has been exacerbating all these factors.

Brown Shoe Co Inc (BWS.N: Quote, Profile, Research) said last week it sees price increases from Chinese shoe manufacturers taking effect in the second half of the year at both the retail and wholesale level.

Mattel Inc (MAT.N: Quote, Profile, Research), which manufacturers most of its toys in China, said earlier this year it will raise prices by roughly 5 - 10 percent in the second half of the year.

Even though China does not allow its currency to float completely freely against the U.S. dollar like the euro or yen, speculators are betting the government will allow faster yuan appreciation to help control inflation.

China's National Bureau of Statistics reported inflation quickened to a near 12-year high of 8.7 percent in February, after hitting 7.1 percent in the prior month. Such high readings have increased pressure on the government to take action, the country's commerce minister said on Wednesday.

There are several other forces at work that will undermine U.S. retailers' ability to get cheap sourcing from China, said Merril Weingrod, head of China Strategies, a consultancy that advises U.S. companies doing business in China.

Among them was a move by China in July to cut rebates on value added tax on more than third of Chinese exports. The government is also promoting greater enforcement of nationally mandated employment benefits. Both policy measures are intended to shift the country more towards a domestic demand-based economy, Weingrod said.

"That's a clear sign China's saying 'we're not underwriting consumers around the world, we're keeping some of this money at home,"' Weingrod said. "What does it mean for U.S. retailers? You're going to pay more, it's inescapable."

Companies seeking to avoid increasing Chinese costs will still face obstacles if they seek cheaper labor elsewhere in Asia, since China not only assembles products, but also provides many of the raw materials.

For example, China's dominance in textile production means apparel makers would still likely have to buy Chinese-made fabric, even if assembly took place elsewhere.

"If you've made investments in China and you have relationships in China, you can't recreate those overnight. Those supply chain linkages are not replaced easily," said Carl Steidtmann, chief economist, at Deloitte Research in New York. "And the falling dollar is still going to follow you."

In the past 12 months, the U.S. dollar has lost ground against every major Asian currency, except the Pakistani rupee.

Vietnam, seen as an alternative low-cost manufacturer to China, has a managed currency, but its central bank last week widened its trading band letting the dong climb to a 16-month high against the dollar.

If the Federal Reserve keeps cutting its benchmark interest rates, the dollar will almost certainly be under further pressure, since lower rates make the currency less attractive to investors seeking high yields.

Short-term interest rate futures show speculators are almost unanimous in their belief the Fed will cut rates by another 0.75 percentage point at its policy meeting next week.

To be sure, the weakness in the dollar can be a boon for companies who sell overseas, since their products become more affordable to overseas consumers, said Todd Slater, citing companies such as Deckers Outdoor Corp (DECK.O: Quote, Profile, Research), the maker of popular UGG boots, VF Corp (VFC.N: Quote, Profile, Research), the owner of the North Face brand and Warnaco Group Inc (WRNC.O: Quote, Profile, Research), the owner of the Calvin Klein Jeans line.

But for retailers who rely on U.S. demand, they will be passing on higher prices to a consumer who has less access to credit to charge their purchases of toys, clothes and gadgets.

Even though the federal funds rate has dropped from 4.25 percent to 3.0 percent so far this year, consumer borrowing rates have not followed suit due to turmoil in credit market.

"The Fed is definitely going to cut again, but that will very little effect on credit card rates," said Steidtmann. "For consumers with average credit, the availability of credit will be lower and the cost of the credit is going to be higher," he said.

Brown Shoe said it is "not yet known" how consumers will respond to higher prices, but analysts say even with $150 billion in stimulus checks on their way, shoppers will still have to cope with the higher costs of food and fuel, leaving them with less cash for discretionary purchases.

"Volume is going get clobbered. Companies could still be profitable, but they'll have to slash their overhead to make up for lower volume," said Peter Schiff, president of Euro Pacific Capital in Darien, Connecticut. "They'll have to shrink to operate in a world where Americans might be spending the same amount money but buying a lot less stuff."

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