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.
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.