From Say Hello to China's Price/Wage spiral:
Well, China has been printing a lot of money for a long time in order to keep the Yuan low which befitted their export sector. As a result of their policy they accumulated massive foreign exchange reserves, and had giant trade surplus. Since China over one billion people and since most of them where farmers up until the 1990's the money printing didn't cause wages to rise dramatically. (Money flows to places where supply is tight and China had abundant labor)
So the money went in to commodity, real estate, and stock prices in China. But now something totally different is happening. China trade surplus is gone, food prices are rising and wages too. This combined with weak exports, a weak euro is killing China Corporation’s margins and we have a classic wage and price spiral.
Since China produces simple products and since China has focused on quantity and not on quality there is no significant productivity growth to offset the money printing, since the movement to the cities was exhausted. China must slow the money printing or risk hyperinflation
From China's Coming Depression and the Peak Of Deflation:
China's money and credit supply is growing at an annual rate of 30%. Credit growth of 30% in China is equivalent to a 10% growth rate in the United States (Since China's economy is a 1/3 of the size of the U.S economy).
China's money supply (M2) is about the size of the equivalent number in the U.S(north of 8 trillion U.S$) So, the affect of the 30% growth rate in China's money supply is affecting the world's economy as if the United States M2 was growing at the same rate.
From China’s Food Price Inflation Is Starting to Affect the Rest of the World
China has been suffering from surging wage and food prices for the last few months. However, since there were a lot of restrictions on imports prices in China were much higher than in the rest of the world, especially the United States and Europe. But recent developments signal that the arbitrage is starting to close. The direct implication of this development is that the Federal Reserve’s hands are tied even more, it simply can’t resume Q.E until the demand from China cools down, and that is happening during a classic deflationary spiral in the Western Economies.
The arbitrage in corn prices is being closed via a surge in exports from the United States to China:
China has purchased more U.S. corn this year than at any point since 1995 as soaring domestic prices and rising needs for livestock feed have boosted China’s demand for corn from the world’s top exporter.
One cargo of U.S. corn has already landed in China and started unloading and two to three more are scheduled to begin loading at U.S. ports this week, tempering at least some fears that China could not take delivery of the corn.
Only a month has passed since these articles were published and yet wheat prices have risen almost 50% from their lows, while corn and rice prices closely followed
Wheat 1 month chart
The arbitrage between grain prices in China and the United has been closing rapidly, although wheat prices in China are2,000 Yuan per ton, which is about 8.3 dollars per bushel. That is compared to current prices of 7.5 dollars per bushel in the United States. Droughts in China and Russia didn’t help of course but the fact remains that with prices going up so rapidly any newly created money (Be it the Fed’s Q.E 2.0 or a fresh stimulus by the Chinese government) will go straight into the price of grains. And in China, food prices are anchor of social stability.
That is why China is trying to desperately regulate the price of wheat and other grains:
Since the rise of domestic wheat prices the state's efforts to regulate and control the market have been strengthened, through the suspension of prop acquisitions, and the storage of 4.5 million tons per week. That was done in order to keep the market price in check, and to rain in speculation through related penalties. In order to do so, since July 23 the government has declared that the purchase of more than five million tons of wheat is illegal. This new order will prevent speculation and keep prices stable.
The price of wheat in North China Huang-Huai region is still higher than the new minimum purchase price. In order to stabilize the minimum purchase price of wheat the government decided to outlaw the purchasing and storage by company acquisitions. Since these acquisitions are the reason for the reduction of supply in the market. “
We all know how regulation of food prices end, and it should be clear to Chinese government as well, but I guess they will need to find out the hard way. Unfortunately too many ordinary Chinese will suffer in the process while those who are responsible for the mess will keep on giving speeches and lectures on a very full stomach.
Anyway, despite the attempts of the Chinese government, wheat prices in Zhengmai market are still 2,426 Yuan per ton compared to the spot price of 2,000 Yuan per ton.
How the price of food is preventing the government and the central bank from further inflating the real estate bubble.
Remember when in July 2008 everybody was worried about inflation? The dollar was tanking, oil was at 147$/bbl, and food prices were skyrocketing. A few months later, Lehman Brothers collapsed, Fannie and Freddie were nationalized, the auto sector was bailed out and seemingly untouchable mega banks were bankrupt. The focus shifted almost overnight from an inflationary scare to a deflationary one. Only then could Bernanke implement the promise that he gave Milton Freedman at his birthday and “drop money out of helicopters”. The great monetary experiment known as quantitative easing had begun.
What does all of this have to do with China? The Chinese policy makers are confronting the same dilemma that U.S policy makers were confronted with in July 2008. They are faced with a potential housing and banking implosion while at the same time facing significant inflationary pressures. Although both money supply growth and credit growth have slowed down, it did nothing to stop the wage and food price inflation. However, the slowing of the monetary growth has begun to affect the housing market.
China's money supply(M2) growth rate
New loans in China (billions of Yuan)
So China is forced to choose between a rock (food price inflation) and hard place (a housing and banking crisis). Only time will tell what path they wish to go by. In any case, be it food price inflation or be it massive unemployment, the Chinese regime will be faced with a very angry public.
Investment implications
I have recommended in the past using gold (via GLD or PHYS) and food (via DBA or futures) as a hedge against a large short position on the Chinese ETF (FXI), the Australian ETF(EWA), Canadian banks, and commodity producers.(such as Rio Tinto)
Some of the shorts have gone well, and some have yet to mature. The hedges in gold and grains have done remarkably well.
Since the Chinese market has fallen so much it may be a good idea to move the focus of the short side to the markets that hadn’t yet suffered from a serious downturn such as Australia and Canada.
The inflationary headwinds from China are keeping the hands of the Federal Reserve and the ECB tied and as a result I believe that a serious downturn in the economies of Europe and the United States is inevitable, if not already underway. I remain extremely bearish both on the Euro and on the European Banks (as I have been since December 2009), especially the Germans (like Deuteche Bank) and the French ones (such as Societe General) and since we have had a strong rally in Europe in the recent months I believe that shorting the European Banks, or the ETF’s of the so called PIIGS (Portugal, Ireland, Italy, Greece, and Spain) will also pay off over the coming months.
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