China: trap or deceleration?

The nice thing, which none of us will notice, about the market reaction to yesterday’s news about prairie farmers’ intentions to plant a gigantic crop this spring is that the market really doesn’t care. A few million extra acres? So what?

At least, it doesn’t care on the downside. What I mean is, us growing big crops up here doesn’t make anyone think that prices could weaken. Yes, we are a small crop compared to the national crops of countries like the U.S. or Brazil, so we shouldn’t expect to move the market too much just by ourselves. But there haven been times when a bunch of canola being seeded would have rattled markets.

However, for most of a decade we’ve been living in a time in which the world economy seems able to consume anything we produce – at top dollar. So the only thing that’s going to rattle the market from us, generally, is if it looks like we won’t produce enough.

How is this possible? One word: China.

China’s consuming all the canola we can produce and stocks are getting very low right now, hence the very high old crop prices and high new crop prices. The inverse between old and new crop prices shows how anxious world buyers are about getting supply in the next few months. China is sucking in almost all commodities at a great rate and that’s let the commodity complex stay high for years, including the crops and meats.

Almost 10 years ago I went down to Brazil to check out the vast new acreages being developed there for soybean and corn production, and a big part of the Brazil chatter of those days was the generalized terror in farmer and ag circles about the devastating effect all those extra tens of millions of tonnes of crop production would do to prices. As well all know now, prices went the opposite way and we’re all getting rich. (Well, actually, all you guys who actually get to grow crops and didn’t have bad weather for a few years have had a chance to make good money. Me, I just write about the stuff, so I’m not in on the enriching experience. On the other hand, a drought or flood doesn’t wipe out my finances for a year or decade, so I’m not complaining. Much. I’m whining a bit, though . . .)

The reason is China, as well as strong demand from across the world. But China alone imports all the extra production that Brazil has developed in the past 10 years, so it really hasn’t hurt us.

However – and this “However” is where I have been heading for a few hundred words – we have so much of crops’ price structure based upon continuing and growing demand that any threat to that growth trajectory scares the manure out of us. We not only need to continue to buy the same amount of commodities and things like canola and soybeans, but need that consumption to increase. So far, for many years, it has been doing so. But China right now is in a well-publicized economic slowdown and everyone in commodities journalism is watching it anxiously. (I did a story on it in last week’s paper, just to get on the bandwagon. Did an almost identical story a few months ago too.) Everyone thinks China needs to slow down in order to iron out some of the unsustainable problems in their economy, such as overcooked real estate and stock prices, and the present slowdown has deftly slowed without stalling the Chinese economy and has cooled asset prices. But a “hard landing” into recession would spell bad news for farmers and other commodity producers and exporters.

How about the longer term outlook? Mid-term recession or not, we rely on China to keep growing and growing and growing in the future in order to soak up all the crop yield advances we’re almost certain to achieve in the coming years. Will Chinese demand keep growing like pot plants in a grow-op?

That’s where more profound worries lie. China has hit the level at which many developing nations begin to top-out and their economic progress stalls. It’s called the “middle income trap” and it means that developing nations are able to catch up dramatically to Western industrialized nations by aping Western methods, structures and science, but they have trouble catching up all the way to Western levels. Their growth rate drops back to the kind of moderate levels we get here. For commodity producers, that could mean that China’s ever-expanding commodity hunger will dramatically stop expanding and all our yield and production advances will begin beating down prices. If production growth outstrips demand growth, we’ve got trouble.

Richard Sharma of Morgan Stanley addressed this point in a recent Bloomberg radio interview I downloaded, and he’s concerned about the potential of China falling into the trap, but thinks the odds are still in favour of China having a better result than some developing nations. Rather than a middle income “trap,” it will probably find a way to keep growing, but more slowly.

“China is likely to experience what is a middle income deceleration, that at these sort of per capita income levels growth will slow down. I think that could be a pretty big disappointment to many sort of China bulls,” Sharma said during On the Economy. (Which you can all download free from Bloomberg radio through iTunes. It’s great. My bible.)

Food demand is always stronger than other commodity demand, because people keep eating even with weak econ growth and governments are keen to keep their populations well-fed especially in tough times, so crop and meat demand isn’t likely to be the first commodities hit by any slowdown. They aren’t being hit now, but other commodities are, so that seems to prove the point.

But Sharma’s concern about the extreme bullishness of many people about China is a good caution to farmers who are making investment decisions based on assumptions of always-high crop prices. We shouldn’t be expecting China to keep growing at the rates it’s growing now. That’s what we expected with Japan in the 1980s and it has been in recession and deflation since 1989. China might do better, but there’s a wall coming closer.

“The more mature you become as an economy the harder it is to grow at the breakneck pace at which China has grown over the past three decades, and particularly over the past decade,” said Sharma.

Disclaimer: I have been a China skeptic for years, and I have been wrong for years. My quoting Sharma is probably just a case of “confirmation bias,” in which we hear, absorb and repeat stuff that agrees with what we already believe. So ignore this entire piece if you’re bullish on China. And if you actually got to the end of this overlong piece, which I doubt, you deserve a coffee break.




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