The Rise in Garment FOB prices: Why, Who, How Much

All the experts agree: Garment FOB prices will rise in 2011, ceterus parabus (all things remaining the same). This must be one of the silliest statements on record, since these same experts also agree that in 2011 little or nothing will remain the same.

This is the problem with all projections—too many variables and too many changes.

However, the question of rising FOB prices is so important that we should at least examine the factors.

WHY PRICES WILL RISE: Prices generally rise for two reason — increased demand and increased costs. In this instance we have both, plus a third

Rising Demand:

2009 was a terrible year for everyone, including the garment industry. As of June 2009 U.S. consumer garment consumption was down a record 13.9%. Imports reached bottom in September down -15%, also a record. As a result many marginal factories closed. 2010 reversed the trend. As of November 2010 consumption had risen a healthy 6.7% compared with the same month 2009 while imports during the same period imports rose by a remarkable 24.6%. Suddenly more customers were placing more goods with fewer factories

The increases in the U.S. were indeed impressive; however the real increased demand came from the developing lead by Asian countries such as India and China where large numbers first-time consumers were now buying fashion garments.

These first-time consumers added a new dimension to global garment demand. In the past, the global garment industry moved in tandem with economic conditions in the traditional industrialized countries — the U.S., EU, Japan, Canada etc. Recession in the U.S. or Europe translated into lower demand for garment imports, while good times in the U.S. or Europe meant higher demand. However, the industrialized countries will no longer be the catalyst for change. The addition of these new consumers will shift the focus to the new emerging markets. Economic growth in China and India will add literally hundreds of millions of new consumers each year. This rising demand will lead to rising FOB prices.

Rising Costs:

Much has been made of recent spike in material and labor costs.

Raw materials prices have gone through the roof. From 1970 to 2011 cotton futures prices averaged $62.52. As of February 2011 the futures price stood at a record high of $167.86, increasing 143% in the past 12 months alone.

Much of this can be attributed to speculation. It is certainly true that during the past year virtually all agricultural commodities have increased dramatically — Soybeans +57%, wheat +56%, corn +74%. However, speculators notwithstanding the big push has been due to the entry of new consumers in the market place. Economic development, particularly in Asia has resulted in better diets. Here too we must expect that this demand will dramatically increase each year.

The cost of labor has gone up as increasing demand has created labor shortages throughout the garment exporting world. We used to assume that China and India, each with their teeming billions would be an inexhaustible source of cheap labor. Circumstances have forced us to realign last year’s assumptions with this year’s reality. Labor is becoming scarce. Wages are rising and will continue to rise. Furthermore, we can no longer rely on local governments to keep wages down. Government leaders have finally been forced to conclude that they cannot retain power unless their citizens see benefits from that power. The global garment industry which has traditionally paid the lowest wages will face the highest wage increases.

In 2011 FOB prices will indubitably rise. In fact FOB prices have rising since August, which means that after allowing for the time between contract negotiation and stock garment delivery, FOB prices have been moving up since March/April 2010.

Secular Trends: Rising costs and/or rising demand are the usual reasons for prices rises. However, we face a third, more unusual reason. Simply put, prices rise because it is past time for prices to rise. The era of ever cheaper garments is over. In a world where prices for virtually all products invariably rise every year — the average FOB price for imported garments has fallen every year since 1997. In 13 years, prices have fallen 24%. In part this was due to higher productivity. However, as time progressed further reductions were achieved first by squeezing the factory, then by squeezing the product — long sleeves, became short sleeves which became no sleeves. In 2010, we finally reached bottom, at which point there was no place to go, but up.

WHOSE PRICES WILL RISE Rising prices do not necessarily mean changing sourcing patterns. If prices go up everywhere there is no benefit to move production from one country to another. However, should prices rise faster and higher in one country; i.e., China, then to remain competitive customers must find new sources of production. This is the core of the real debate about rising prices

In the fight to remain competitive, China faces one special prices: the RMB’s artificially low value.

The first question is, Will China revalue their currency?

My answer is they will have no choice. Reducing the value of ones currency is a policy decision. Keeping it low indefinitely requires something akin to the ability to repeal the laws of physics. Five months ago, China’s foreign currency reserves were increasing at the rate of $1 billion a day. Today that figure has risen to $2 billion dollars per day.

This is something like a giant balloon into which you pushing 2 billion pounds of gas per day. You have but 3 choices:

1. Stop pushing in the gas; i.e., reduce exports by cutting out subsidies and increase imports by cutting out trade barriers.

2. Siphon off the gas; i.e., increase government revenue by raising profit tax.

3. Wait for the balloon to explode.

Regrettably choices 1 and 2 are no longer politically feasible. This is how it works

The PRC government operates by consensus between divers and powerful interest groups. The old guard, Deng Xiaoping and Zhu Rongji were able to effect real change because they held real power. They were the consensus builders. The current and upcoming PRC leaders are of a far different ilk than their predecessors. They are victims of consensus, appointed to power because they will go along with a consensus arrived at, by China’s true leaders — the big exporting SOEs, the military etc. 20 years ago Deng was able to reorganize the State Owned Enterprises to become profit making companies. Today those SOEs are reorganizing the PRC government to ensure continued profits by subsidizing ever growing exports.

Monetary policy will not work. The PRC Government lacks the power to impose fiscal reform. Eventually, economic conditions will force change with losses which will make the U.S. economic recovery programs look like penny-ante poker.

In the next 24 months, we must expect the RMB to revalue by something approaching 20%.

HOW MUCH WILL PRICES RISE:

Once again, much depends on China. To understand the problem, consider what happened last time. From July 2005 to July 2008 China revalued the RMB by a whopping 21%. During the same period, the average price of a made-in-China garment increased by 17%. However, once the RMB ceased moving up in value, rather than remaining stable the average price of a made in China garment fell by 13% with the result that between July 2005 and November 2010, the average price of a made-in-China garment rose a feeble 2%.

There is no doubt that costs are rising. I am quite sure that China will revalue its currency by a substantial number, perhaps 20%. However, in the world of garments rising costs, and revalued currency do not necessarily result in rising prices. It all depends on politics. In this case how much more air the PRC government is willing to pump into their balloon.

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  5. JeffG says:

    There is major profit and margin to be found in producing garments domestically here in the USA. By placing seasonal bets solely on fabric, and cutting and assembling the patterns, sizes, and styles selling best, retailers and manufacturers could be preserving margin and taking advantage of the higher quality and production predictablility offered here in the USA. Not to mention boosting our economy and creating more jobs here, therefore more consumers here to purchase product.

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