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June 12th, 2010

American companies across industry sectors are complaining they can’t get their products made. “China won’t make our stuff,” one recently told me. Some traders have been informed of longer lead times, others have been offered excuses that make little sense. I ran across the following graph, which I find interesting, and which may be illuminating.

1The red line represents year-on-year growth of China’s imports. The blue line indicates year-on-year export growth. Remember that China imports include not only goods that locals consume, such as Microsoft software or BMW automobiles, but also large volumes of raw materials that get turned into products that are reexported. For example, China takes in large volumes of timber from Canada, which is then made into kitchen cabinets and bedroom sets sold in the United States. The more China exports, the more it needs first to import.

From the graph you can see that China suffered a blow during the global financial crisis. Import and export growth rates were steady for quite a long time, and then they dipped towards zero around this time last year. In 2010, orders bounced back in a big way, and China has been scrambling to bring in raw materials to meet sudden demand.

Perhaps the most interesting part of the graph is the third “blue bar” from the right. These blue bars represent China’s trade balance. When the bar is above the line, China has realized a trade surplus. When it is below the line, China has registered a trade deficit. China almost never registers a trade deficit as exports tend to outstrip imports, but the economy saw a deficit three months ago. The mainstream media happily reported on the event, suggesting that it was a sign of a more balanced trade situation. Little did anyone suspect.

The sudden inflow of imports was in large part connected to a ramping up of orders. Good news for those who want to know if the global economy is on the mend, bad news if it means we are returning to a period of growing trade imbalances with China. It’s going to take a few months to understand what we are going through now, and I’m as curious as anyone to see where we end up.

2The graph, by the way, reminds me of a lesson from business school, a phenomenon known as the Bullwhip effect.

Some may have a hard time understanding the problem with too many orders. Speaking with a friend about this yesterday, I asked him to imagine what it would be like if his business suddenly increased 100%. “Sounds good,” I suggested, and then I asked what if every business in the country realized the same overnight doubling. You might have trouble getting hold of stock. There might be pricing pressure. Shipping might be harder to come by as capacity was suddenly constrained. You might have trouble finding workers.

This is what’s happening in China. Shipping costs have shot up. Workers, seeing a sudden increase in demand for their labor, are demanding higher wages. It’s a supply chain nightmare.

For those who have standing orders in China, expect that the production situation will clear up over the next few months. For economists and analysts tracking trade figures and other macroeconomic indicators, I wouldn’t be surprised if we are entering a newer and even grander period of import/export trade imbalance with China. That monthly trade deficit that China ran in March 2010 might be seen as marking the beginning of such an era.

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