April 8, 2004

Blame China?

Higher Prices? Thank China

The same global economic forces that have consumers paying higher prices at the gasoline pump may soon have them shelling out more money for their beds, their appliances, and even their food.

In a trend apparent at the start of the year that has accelerated in recent weeks, prices have been soaring for nearly every one of the world's major commodities--the raw materials like metals, grains, and fuels that are essential to making the familiar products of modern life. Until now, consumers remained blissfully unaware of the chaos in the commodities markets, because manufacturers have absorbed the increased cost of doing business rather than raise price tags in auto showrooms and department stores. But the strain is beginning to show, and a few companies have indicated they will ask customers to help share the burden.

Most economists doubt that the run-up in raw materials will lead to widespread inflation. The Federal Reserve clearly has debated the issue but concluded that other factors in the economy--such as relatively high unemployment--will keep the risk of spiraling prices low. Nevertheless, a few analysts see the current rumblings as the beginning of a major shift in the global economy, in which new wealth and continued population growth in Asian countries force U.S. consumers to pay more for limited world resources.

Bill O'Neill, a principal with commodities research firm LOGIC Advisors in New Jersey, can sum up the reason for the commodities upsurge in a single word: China. "The warning signs were out there that Chinese demand for industrial commodities would be strong, but I think it happened quicker than some people thought," he says. With its economy growing at an annual rate of nearly 10 percent, even while adding 11 million per year to its 1.3 billion population, China has been gobbling up raw materials. Markets are merely reflecting the fact that for the first time, the world's most populous country now has a significant number of citizens who can afford cars, meat, and better housing.


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Still, it's hard to believe that China's voracious appetite won't seriously affect the No. 1 consumer nation. With oil, where pump prices move in step with the price of crude oil, consumers already are feeling the impact of China's 30 percent growth in demand last year (it's now the world's No. 2 consumer of petroleum). Whether or not the Organization of Petroleum Exporting Countries holds to the production cuts it made last week, worldwide demand for oil will continue to increase thanks to China, pushing up the cost of all manufacturing and transportation.

Then there's food. China is expanding its livestock herds to meet its citizens' demands for more meat. As a result, the Middle Kingdom has dramatically increased its imports of soybeans, a prime component of cattle feed. China is expected to import 25 million tons of soybeans this year, a 14 percent increase over last year. Soybean prices in the United States, in turn, rose to their highest level in 15 years. Also, while China had been a minor player in the U.S. wheat market, buying just 78,800 metric tons a year ago, over the past year, that figure has ballooned to 1.4 million metric tons. Leading cereal maker Kellogg said last week it is feeling pressure from the grain market and is considering price hikes.

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But a few observers see dire warnings for the future. Lester Brown, agricultural economist and founder of the Earth Policy Institute, thinks the recent increases in grain values are merely "the early tremors before the quake." Environmental degradation in China--loss of irrigation water and rapid urban expansion--has dramatically shrunk the land available for crops. The Gobi desert is growing by 4,000 square miles each year because of these occurrences. China's need for imports will dramatically grow as a result, he argues. And as China turns to the world market, "higher food prices could become a permanent part of the economic landscape," Brown warns.

On the oil front, Stephen Leeb, who manages the MegaTrends fund for U.S. Global Investors, argues that the world is entering a new era in which supply cannot keep up with demand. Although he has no predictions for the next few months (and admits that crude oil prices could drop somewhat, as they did last week), Leeb predicts a dramatic increase over the next five to 10 years. "The stark fact is that the world has very little excess capacity, and it's all in the hands of a very volatile country--Saudi Arabia," says Leeb. In his recent book, The Oil Factor, he predicts $100-a-barrel oil will lead to global inflation. "We have to pray it does so in a gradual fashion," he says.

Posted by Ithildin at April 8, 2004 12:08 PM | PROCURE FINE OLD WORLD ABSINTHE