The China domino

The stated goal of the Hu Jintao-led Chinese government is a “harmonious society”. Perhaps that is why the word “Egypt” was blocked on certain search engines over the weekend. Multiple factors are in play in Egypt, but there is one vital similarity with China: Food inflation of a breadth and severity that few in the market appreciate.

China’s food inflation is different from its other inflations, notably real estate and wages. It is more dangerous. For as much as there have been spasmodic protests around the price and availability of homes and pay, and as much as there has been a gross misallocation of capital – whether viewed from the perspective of urban property investors or the gigantic follies of empty shopping malls and cities – neither wage disputes nor asset price bubbles bring down centralised political regimes.

China’s ruling Communist Party is not the broken coalition of Ireland’s Brian Cowen, nor the discredited government of Gordon Brown. With the national army literally at the party’s sole disposal and an extraordinary network of economic, commercial, media and social control, it would take something a lot more serious to unseat the powers that be; something like food.

With food prices having played a part in destabilising two autocratic regimes in Tunisia and now Egypt (plus possibly more from Yemen to Algeria), it’s time we canvass the unthinkable and ask could the same happen in China?

Firstly, we must consider the external causes of China’s food inflation issues. Foremost is surely the unbalanced global economic recovery, which has coupled raging demand in emerging markets with insipid demand in developed markets. The combination is explosive because the two create a feedback loop of low interest rates and quantitative easing (QE) in the US feeding inflated stock prices at home and commodity prices abroad.

In this blogger’s view, the likelihood is that these dynamics will continue. On Friday, the US Federal Reserve recommitted to completing its QEII bond purchase plan and US Treasury Tim Geithner declared growth still too anaemic to lower unemployment. QEIII is a distinct possibility.

As this blog and other more eminent global commentators like Paul Krugman and Martin Wolf have noted in recent weeks, China is making a mistake in not raising it’s currency to combat these external price pressures.

Moreover, food inflation is now being compounded by the vagaries of politics outside China. As this blogger has described before, markets for strategic commodities (and yes, food is one) do not respond to pressure the way regular markets do.

Rises in price do not suppress demand, in a classic supply/demand curve. Rather, government’s panic and all manner of ill-thought out responses drive demand up further. Just as we saw in 2008, from Russia to Ethiopia to India to Korea, and despite protestations from the United Nations, stockpiling and price controls looks set to boost demand and diminish supply, as described by Javier Blas and Chris Giles in the Financial Times.

That, of course, gives markets the whiff of blood and financialisation drives prices further, as well as setting up negative feedback loops with policy-making that brings the entire free-trading system under pressure.

Another parallel with 2008 is the effect of energy prices. As noted, the food inflation we have already seen has played a role in uprisings against North African autocrats. The direct roles of these nations in the oil market is relatively small, however, the risk of closure in Suez and of further destabilisation of Middle East regimes builds a long-term fear premium into the oil price that has been absent for several years.

The 2008 food inflation clearly demonstrated the importance of oil as an input cost in food production via machinery, transport and fertislizers. Aside from this direct effect, the higher price of oil boosts ethanol demand, even as it is already rising in the US and gobbling up arable land that might be dedicated to grains.

Other forces coming to bear on China’ food inflation ignore all boundaries and borders. Climate is a major, long-term challenge. China has one of the earth’s two major dustbowls, according to a new book, World on the Edge,  by leading agronomist Lester Brown. Brown, who also wrote Who Will Feed China? in 1995, calculates that grain yields fall 10% for every one degree Celsius rise above normal temperatures.

The short-term phenomenon of La Niña dovetials with longer term climactic shifts like global warming and changes we’re seeing to the Arctic and North Atlantic Oscillations.

As the always-excellent asset manager Jeremy Grantham wrote this month in his GMO Quarterly Letter , melting Greenland ice is shifting currents, cooling the Gulf Stream and thus causing this year’s colder northern winter, which climate change deniers are pointing to as prima facie evidence of global warming’s deniability.

Where Grantham doesn’t go, however, is explaining how these changes have potential to further hurt Chinese food production. As peer-reviewed research published in Beijing’s Advances in Atmospheric Sciences and the American Geophysical Union’s Geophysical Research Letters suggests, the relationship is there.

Internally, China has food supply problems too. It’s uniquely rigged system of land use is a contributing factor to food inflation past, present and future. With the best located arable land co-opted by corrupt local governments and property developers in turn, farmers have less and less room to grow.

New York’s Epoch Times reports that in an online poll asking people to summarise what 2010 meant, a quarter of the 7,500 Chinese surveyed used the character “chai”, which means “demolish”.

So how vulnerable is China to these irresistible forces of food inflation? According to Citigroup, China’s weakness is not only high, but highest:

There is no emerging economy whose changes in CPI are more correlated to changes in food prices than is the case in China. China also has, on our measure, one of the smallest output gaps in EM, and one of the loosest monetary policy stances (measured by the difference between the current MCI and the 10-year average).

Or, for an even more stark illustration, the following is from the World Bank:

Food inflation is a problem for China, not just places in Africa, South Asia and the Middle East. And with Australia’s balance of payments and access to cheap global capital entirely dependent upon Chinese demand for two commodities, it is a problem for us as well.

Jonathan Anderson of UBS nominated inflation as the key theme for 2011 (as was “risk on” versus “risk off” in 2010). It’s time to wake up and smell the breakfast. According to UBS and Bloomberg, this month’s worst-performing currencies and stock markets have been from food importers like China, India and the Philippines. The best performers, on the other hand, have been food exporters like Argentina: home of the $5 steak and virtually the only central bank among emerging markets that’s dropping interest rates.

In the immediate cycle, our great and powerful northern customer is careening towards a monetary Waterloo. In the longer term, it is a political one.


  1. Soft commodities have absolutely rocketed over the past months (+70% soybeans, +50% grain etc). It seemed to be on the back of the rest of the speculative commodity boom. Are the food shortages really there or just another case of a shortage of affordable product? Sounds a little like the housing shortage argument.

  2. Ugh, why would you talk about ‘climate change’ and call skeptics ‘deniers’? It discredits you and sours an otherwise excellent column. AGW debate aside, warmer climates and higher CO2 levels result in MORE plantlife. I would have thought this was obvious to any year 8 student stuck in science class or even your average punter travelling to a tropical reigion on holiday.

    At any rate, if you are going to bring environmental politics into this why no mention of the fact that huge areas of farmland have been converted into ‘bio fuel’ producing crops because of government subsidies for ethanol? Thus pushing food prices up dramatically. Why no mention of continued, irrational Green/environmentalist, opposition to GM crops designed for higher yields in less productive soil?

    These two factors have had a much bigger influence on world food prices than so called ‘global warming’, of which there has been none for over a decade (Arctic ice levels have dropped by the reverse is true in the South). Why no mention of them?

    • Statement:”that grain yields fall 10% for every one degree Celsius rise above normal temperatures.” does not have any scientific support what so ever.

      But you forgot to mention how GM crops affect demand side by forcefully reducing population.

    • “I do mention ethanol and its use of arable land…”

      Apologies, I’m at work at have to skim over a lot of things when I get a spare 30 seconds.

      Agree to disagree it is.

  3. threedogsandakid

    This is a good article and raises some excellent points for consideration. I think a little more geopolitical input makes this already top blog even better. Australia is not immune from the implications of global events.

    Actually, earlier I left a comment re China on your links post – then when I come back to Macrobusiness you’ve already covered it- and so well!

    Anyway, lots around about impending food crisis, I think definitely a combination of agricultural/environment factors and and the heroes at the Chicago Mercantile Exchange.

    But in regards to global food inflation, not to worry, Citibank to the rescue:

    The Yuan (if interested read his other piece “China must kill the dollar”

    China angry:

    “Note the extreme volatility in silver. It was actually underperforming gold until the short squeeze breakout began in the second half of 2010. It is quite possible that this short squeeze was triggered, at least in part, by the Fed’s announcement of a second round of quantitative easing and the further debasement of the dollar. That second round was a signal of their monetary policy intentions. The Fed will print to the limit of the bond and the dollar in a de facto default on the debts. And this is what has China angry.

    When it becomes clear that the Fed will be doing quantitative easing for quite some time, it will be progressively harder for the bully boys in the bullion banks to keep ‘a lid on things,’ with a wink and a nod from the regulators. And then it gets even more interesting to say the least.”

    Ahhh, to live in interesting times…


  4. I enjoy your articles and I would like to contribute in the context of this post by saying:

    1. Rice feeds ~75% of the World’s population,
    2. Rice is consumed within ~15 km of where it has been grown,
    3. Rice is not at all understood by the West
    4. Only ~5% of the rice grown goes to the markets.
    5. In ~2000 China massively overhauled its storage facilities and distribution infrastructures for grains within the Country.
    6. Most grain losses occur from disease (rusts/fungi), rot (bad storage), theft cum pilfering, skill losses (female rights) in planting, water problems such as pollution and late rains, etc.
    7. Most Rice markets are fixed and manipulated by the US big 10 and Traders. It’s is not a big market. There are huge fleets of floating cargoes controlled by the likes of Carghils that really set the price of grains in private negotiations with the help of huge US grower subsidies (denied by nevertheless true).
    8. Most countries are held to ransom by the US over the above and therefore the markets are false and manipulated by the US
    9. The US utilizes and justifies its rice production for its foreign Policy.
    10. There are two main types of Rice – 8 month single crop per annum – Northern China, Japan, Korea, Italy and multiple rice crops per annum in the tropical belts. As China became more affluent its appetite grew from the latter to the former.
    11. The most fertile areas for rice are those areas most affected by typhoons and climatic disasters.
    12. As is the case in most countries, the rice growing areas will not suffer much from price inflation and China has much of its populations still in this agricultural pursuit, but many have gone to the Cities where adverse effects will be felt.
    13. All in all, if food prices go ballistic in China, the government will fall in tune to the global dance, and it is starting to tap along wit the music now.
    14. The Government of China is not as stupid and incompetent as the “leadership” of the West and they relish political leverage through diplomatic game whereby I doubt if the US has really any idea of what is going on as the Big Picture. Obama just never had the plot nor that poor fool and clown VP Biden.

    15. No country is co-operating with any other country now – what you see is just diplomatic pretense; uncoupling will have consequences and serious ramification and China knows that to survive it will need to cut some strings at that precise moment. The change then will become instantaneous.

    BTW the reason that Mao beat the Americans and KMT (they still have offices in Australia) was because of Rice; they could eat as they marched and for this reason, the US will never attack China. Maybe Julia & KRudd will, but the US will not.

    • threedogsandakid

      thanks for this interesting input – but what about roger’s et al being bullish on the price of rice…tried to find a video which claimed that the chinese controlled rice futures but seems lost in the ether – perhaps you know of it?

      • I don’t know these days as I have been out of it for 9 years But, China can easily control the market if they want and this was one of the reasons that they upgraded their silo storage and associated infrastructures and distribution chains.

        The problems are the US big 10 private companies who prey on the small vulnerable Nations with full US government backing. Asia really has no delivery storage facilities like the US and hence the disadvantageous leverage the US has particularly with massively huge floating grain storage / cargo which is constantly cruising the oceans aimlessly, until sailing instructions to a specific Port are received.

        It is the most crippling and criminal cartel in the World and is US dominated and these people are totally ruthless (besides being ignorant and without any human values at al), you really have no idea as to this extent. Most emerging nations fear them , except China – but that said, the deal in all grains and move like locusts, from disaster to disaster profiteering on misery and hunger. They make the Russian mafia look like multi-denominational choir boys.

        But, these guys control the grain prices as they also control most of the deliver silo storage throughout North America. I have seen no evidence that China has since 2000 to present ever challenged their dominance. You also need to understand that 3 crops per year – even x4 crop rice (padi) pa, is possible in the tropical areas and 95% of crop rice is eaten on the spot. That feed Asia. Italian rice (8 month crop ie x1 pa) feed Europe but with growing competition from Vietnam (3/4 crop pa)and Thailand 2 – 3 crops pa) where if Burma, Lao and Cambodia could get their acts together, the World would have far more that it needs.

        There are solutions there always are but they are not easily introduced. Call it “without prejudice” – it’s a real nasty game.

      • threedogsandakid

        From zerohedge today:


        “As can be seen on the chart below, RRH jumped by 50 cents, the maximum allowed before a limit up lock, to close $15.51 on the CBOT, which is 5.5 cents away from the one year high. We are fairly confident that tomorrow we will see a new 52 week high, as evil, evil speculators decide to go for the ultimate PBOC put.”

  5. There is a statement here which I wuold argue is not quite accurate. It is;

    “The combination is explosive because the two create a feedback loop of low interest rates and quantitative easing (QE) in the US feeding inflated stock prices at home and commodity prices abroad.”

    QE only feeds into commodity prices abroad if other countries are running less than sound monetary/FX policies.

    I agree most commodities are priced in USD, however the USD through QE will devalue. Now Panama itself I know of does not have a central bank and uses direct currency from the US, so they may be suffering, however a country like China will get this inflation because they elect to imlpicity peg their currency to the USD, thus inflate their own currency/economy.

    There’s no way that because of the extra USD’s floating around, that the average US citizen is electing to buy more global sources of wheat, rice, or any other soft commodity.

    A sound(er) monetary/FX policy would negate the USD global price, by an increasing domestic dollar.

  6. I copied and pasted the following post at least 200 times in the last 3 weeks. Pay attention to the language on Egypt. Nothing will trigger social upheaval like food price increases in the 3rd world.

    There is no, repeat no, food shortage on the planet today. Sort of… Using the United Nations suggested daily calorie intake there is more than sufficient foodstuffs produced annually, globally. Period. Now then, the question is how you use them….for example, if you wanted to bring the daily calorie level in both China and India up to the U.N. level it would take an additional, not total but additional, 31 million tons of foodstuffs. To put that in perspective the U. S. ethanol fraud consumed 165 million tons of corn during 2010. China has 2.3 trillion dollars in Treasuries but chooses not to expend it on foodstuffs for its own population. India was a net exporter of wheat in 2010…..I had the opportunity to have dinner with the Chairman of one of the largest commodity/food processors in the world over the holidays….there is no food shortage…and the American ethanol scam has absolutely destroyed relationships with food importers from the U.S. , like Egypt for example, that took decades to develop….and now for some Physics: if ethanol were in fact a “sum positive” they would use ethanol as the energy source to produce (boil/distill) more ethanol/corn mash…..and they, the ethanol producers, don’t……because it consumes more energy to make a gallon than you get out of it (referred to as the “thermal load factor”)….It’s nothing like an oil refinery that uses part of the barrel of crude oil to power the refinery.
    Just think- 40% of the American corn crop now goes for the 10% gasoline EPA mandated blend rate yet the EPA is pushing to raise the blend rate to 15%–or 60% of Americas corn crop. As an aside 80% of the canola crop, a premium cooking oil, is used for bio-fuels in Germany. Double the price of corn and bull doze another million acres of Amazon jungle to plant; triple the price of tortillas and watch the Mexicans pour north across the border. Noted: Chuck Grasley, the erstwhile Republican Senator, is the mouthpiece for the ethanol scam. He farms 4,120 acres of Iowa corn ground. My source tells me that without the ethanol scam (and it was renewed for only 1 year…) the price of wheat goes to 4$ and corn to $3.35.

    • threedogsandakid

      FYI are the economics of Ethanol?


      Ronald R. Cooke, author of Oil, Jihad & Destiny…Cooke describes a true taxpayer boondoggle:

      “It costs money to store, transport and blend ethanol with gasoline. Since ethanol absorbs water, and water is corrosive to pipeline components, it must be transported by tanker to the distribution point where it is blended with gasoline for delivery to your gas station. That’s expensive transportation. It costs more to make a gasoline that can be blended with ethanol. Ethanol is lost through vaporization and contamination during this process. Gasoline/ethanol fuel blends that have been contaminated with water degrade the efficiency of combustion. E-85 ethanol is corrosive to the seals and fuel systems of most of our existing engines (including boats, generators, lawn mowers, hand power tools, etc.), and can not be dispensed through existing gas station pumps. And finally, ethanol has about 30 percent less energy per gallon than gasoline. That means the fuel economy of a vehicle running on E-85 will be about 25% less than a comparable vehicle running on gasoline.”

      “The 107 million tons of grain that went to U.S. ethanol distilleries in 2009 was enough to feed 330 million people for one year at average world consumption levels. More than a quarter of the total U.S. grain crop was turned into ethanol to fuel cars last year.”


  7. Its only a matter of time till everyone in the world and govts realize that China is not the envy of economics. The Chinese have printed more money than the US. Google that. Australia is in for a world of hurt when China’s economy comes tumbling town. It will be interesting to read everyones posts then. I mean seriously does everyone in the world want China to control everything. I just read an article where they are trying to keep people from reading about Egypt so it doesnt create social unrest in China. AND YOU WANT THE YUAN TO BE THE WORLD CURRENCY WITH CHINA IN CONTROL. Has everyone in the Western World lost there minds wanting China to be the World Leader.

  8. A recent study by the French National Institute for Agricultural Research confirms James Herman’s above statements:

    All that is needed is a more efficient allocation of resources. For example, only a small percentage of global soybean supply goes to human consumption. More than 90% is processed into feed for livestock.

    Ethanol/biofuels are only environmentally effective when waste material from food production is used. We know how an ethanol based economy fails, look at Brazil’s experience from the mid 1970’s to the 1990’s…

  9. The oft-repeated claim that global warming reduces rainfall is not supported by the archaeological record.

    The record shows that warmer periods are wetter on balance, while cooler periods are drier.

    Sudden climate change is terribly dangerous for many reasons — mass extinctions, mass migrations, ecological collapse — but reduced rainfall simply is not on the list.