My Blog

April 23, 2008

WED 23 APR

Food prices and energy shortages By Michael Pettis

I had lunch with a senior banker from a major Chinese bank today.  He is based in Shenzhen, across the border from Hong Kong in the southern province of Guangdong.  Among other things he told me that lines at gasoline stations are getting terrible, in part because a lot of Hong Kong residents drive to the mainland to fill their gas tanks.  Gasoline on the mainland is at less than the half global price, so this isn’t much of a surprise.  He also told me that he thinks actual inflation is higher than the headline CPI number.  That isn’t a big surprise either, I guess.

 

Finally we discussed concerns about a coal shortage, and I read in today’s Xinhua a confirming article that claims that coal reserves have fallen to a 12-day supply, which I think I understand from the Xinhua article is a record low level, even less than March’s already-worrisome 15-day supply.  The combination of low coal reserves and gasoline shortages means, I think, that it is going to be hard to keep a lid on energy prices.  I wouldn’t be surprised to see energy prices, which are controlled in China, rise in the next few weeks, even amid all the worry about spreading inflation. 

 

The fact is I don’t think that allowing energy prices to rise will increase inflation in China.  I think this widely-held idea is based on a misconception of the source of Chinese inflation.  The inflationary pressures here are monetary in origin, and just as rising food prices have absorbed much of this pressure and prevented it so far from spreading to non-food goods and services, frozen energy prices are causing upward pressure on non-energy prices.  And they are causing shortages too, of course.

 

Meanwhile there are two interesting, and disturbing, articles in today’s South China Morning Post on global and Chinese food supply.  One of them is subtitled “Supply jitters intensify as signs of shortage emerge in US, world’s breadbasket,” and this more or less describes the contents of the article pretty accurately.  Food production in the US, the world’s largest, as well as in other important producer countries such as Brazil and Argentina, is under severe pressure and causing escalating price rises.  In the US the culprits are partly weather and partly the diversion of crops for the increased production of bio-fuels.  Among other things the article mentions that there has been a spike of demand for wheat and grain in certain shops in Canada and the US, and that this spike may be a consequence of hoarding.  I find it hard to believe that there is hoarding going on in the US, but just the fact that they are talking about it is interesting.

 

In response a number of Asian governments are curbing rice exports, and officials at the Asian Development Bank are complaining bitterly.  According to the South China Morning Post, “With poorer nations struggling to find supplies, the Asian Development Bank criticised rice export bans, saying governments should instead use fiscal measures to help the poor.”  They quote Rajat Nag, the ADB’s managing director general, as saying “Banning of exports is no different from hoarding at a national level.”

 

Be that as it may, a lot of countries, including China, are limiting food exports in an attempt to keep prices low at home.  The second article from today’s South China Morning Post discusses the food prospects in China.  The article points out that China’s growing population, and its rising per capita income, are being accompanied by a sharp reduction in the amount of cultivated farmland as much of the best farmland falls to rapid urban development.  In one very important way this is a good thing, of course, because it means that Chinese wealth is growing and tens of millions of people are being lifted out of poverty.  But of course in the short-term it also means that there will be continued pressure on food prices, and this particularly hurts the newly urbanized poor.

 

“China is feeling the rising pressure to grow enough grain to feed its population,” said Wen Tiejun , dean of the School of Agricultural Economics and Rural Development at Renmin University.  However, China did have a fourth consecutive growth in grain output last year which met more than 95 per cent of domestic needs, Professor Wen noted.

 

Senior economist with Asian Development Bank, Zhuang Jian, said arable land for grain production had given way to rapid industrialisation. At the same time there was a growing population and changes in consumption habits that had widened the gap between supply and demand of grain.

 

They quote the ADB’s Mr. Zhuang as saying that “China is facing the most severe agricultural challenge [of any country] as the world's most populous nation sees the most severe imbalance between population and land.” 

 

A lot of these problems are problems of success.  As China develops it is natural that it turns away from agricultural production, although my understanding is that there is still a lot of room for China to improve its agricultural productivity, which in some areas is extremely low.  The point is that success brings with it a new set of problems, and unfortunately we are going through a stage where a series of different, and often unrelated, problems are converging upon each other.

 

One last thing.  I was pleased to see in today’s Financial Times that the Chinese securities regulators seem to be cracking down on insider activity among fund managers.  Fund managers apparently like to take personal account positions in stocks before their fund takes much larger positions, and of course this allows them to profit from their knowledge of the buying strategies of large players.  Two fund managers were punished yesterday, according to the article.

 

Such punishment, and the public release of details of such cases, is a common tactic – referred to as “killing the rooster to scare the monkey” – used by the regulator in the face of widespread irregularities and malfeasance in the country’s capital markets.  “The scale in China of corruption, poor disclosure, insider trading and market manipulation basically swamps the regulator’s limited resources,” said Fraser Howie, author of a book on China’s capital markets. “This is just how the market works and these guys were either unlucky or stupid.”

 

The CSRC issued a warning to fund management firms through state media yesterday that it was prepared to punish companies whose lax internal controls allowed managers to break trading laws and regulations.  It also ordered firms to monitor all communications of investment managers in the workplace.

 

I often lecture to my students about how damaging this kind of unethical behavior is to China.  It not only represents an unfair transfer of money from investors to cheaters, but much more importantly it is extremely damaging to the long-term functioning of the financial markets, and it helps ensure that Chinese capital markets do a terrible job of allocating capital efficiently.  Let more of them be punished.