The cocktail mix of pig disease, water shortage, and a few hundred million angry farmers in China could lead to a global jump in inflation and some nasty manufacturing disruptions.

According to a recent comment from Gavekal:

"At this stage, the number one constraint to China's impressive growth has to be water." Across the country, millions are experiencing serious water shortages, "and by one estimate, 22% of the nation's farmland is now being affected. The sad tails of droughts and water shortages have lately become a feature of newspaper articles both on the Mainland and in Hong Kong.

"It seems that China is currently facing a two-pronged water problem: First, there isn't enough of it, and the little that there is tends to be concentrated in the more agricultural South, while the desert in the West and the North continue to advance rapidly. Second, the water that China does have is increasingly polluted, and unfit to drink. The main problem is that water use for farmers is heavily subsidized in China: As a result, rural China gets water for only 16 US cents per cubic-meter, which is significantly less than the US$2.50/m3 paid in the US and does not come even close to communicating the scarcity and true cost of delivering the water."

Now comes the scary part:

"However, if the water subsidies were eliminated, a majority of farms would, all of a sudden, become economically unviable. Removing the water subsidies would thus most likely create serious social upheavals and possibly food shortages as well, the worst of both worlds as far as the central government is concerned. Nevertheless, the current system can't last either. Today, China requires more than 10x the amount of water used in the US to produce a dollar of GDP. Unfortunately, the recent spikes in food prices are likely to prevent any bold thinking from the government on this important issue. So the most likely policy response is to keep throwing money, and labor, at the problem (China is spending some US$80bn to build canals to bring water from the South to the North)."

On top of that you add the recent pig disease that swept through 10 provinces in China that decimated the swine population and ramped up pork prices. It has already affected more than two million pigs and killed 400 000 of them. It's also comforting to know that few thing are as essential to the Chinese diet as pork. And if you’re superstitious it's also good to know that 2007 is the Chinese Year of the Pig!

We will continue with an excerpt from The New York Times:

"Steep increases for pork loins and bacon are the most tangible sign that after a decade in which prices have fluctuated but not moved significantly upward, inflation is creeping back into China. In response to this pressure at home, Chinese companies are starting to raise prices for exports, removing what has been a brake on inflation in the West. The crisis over pork prices in China, like the jolt many Americans feel when gasoline prices jump, offers one example of how prices can suddenly soar.

"The Chinese government is struggling to cope - including deliberating whether to sell a snuffling, smelly strategic reserve of hundreds of thousands of live pigs kept at special subsidized farms for precisely the shortage the country is now facing. Chinese officials offer several reasons for the high pig prices. The cost of animal feed has risen by one-quarter in the last year, partly because more corn is being made into ethanol and partly because more prosperous workers are eating more meat. The cost of pig veterinary medicine has soared. Some pig farms, shut down because of low prices last year, were unprepared for strong demand this spring. And outbreaks of disease have killed many pigs, though no reliable estimates of how many are available.

"The most recent statistics from the Agriculture Ministry show that prices for live pigs rose 71.3 percent in April from March, while pork prices climbed 29.3 percent. The price of pork followed pig prices higher in May as well, to the dismay of shoppers."

Maybe it will turn out to be a non-event at the end, but it still reminds us that China's success story could be more fragile than most investors are ready to bet. Stay tuned…

Greg Rehmke comments: 

“The Chinese government is struggling to cope…” Newspapers regularly report that governments or federal agencies working hard to deal with the crisis-of-the-week. We have a impending water shortage in China this week. Last week the headlines were of massive floods in China. This suggests an opportunity to improve infrastructure (though western environmentalists still oppose new dams).

When water is owned and has prices less will be wasted. If Chinese farms cannot compete without “free” water, they will shift to different crops. When farms pay more for water they economize and innovate, and some on the margins go out of business. Chinese farmers, starved of capital for generations, need far fewer workers as they gain access to modern farm machinery and methods. Workers naturally migration to village and city factories. ”Social upheaval” is more the consequence of Chinese government intervention in capital markets, restricting investment in some areas and subsidizing it in others. Chinese economic growth of 10% is celebrated, yet a free China would grow faster with less pollution and resource waste. Michael Cox offers this analogy. One man struggles to clear a path through the jungle. With a machete he can move ahead much faster (up to 10%, say). But when those behind him find the trail, they can go much, much faster. China found the capitalist trail and would have run along it much faster without the remnants of communist bureaucracies "struggling to cope."

An online source reports the U.S. imported 150,000 tons of apple juice concentrate from China in 2006. That takes a lot of water to grow. U.S. customers won’t notice slightly higher prices from less Chinese apple juice, though U.S. orchardists would. Ending water subsidies for apple production in China could benefit many, while harming some in the short term. Higher pork prices hurt the poor but encourage efficient pig farmers to expand, and to clean up their operations to better avoid disease. Will “social upheaval” follow higher pork prices, or just more fish for dinner?





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