Friday, January 14, 2011
Guest post: La Niña, the black swan
This week’s disastrous floods in Queensland have tragically claimed many lives in addition to leaving thousands homeless and without businesses to return to, but the biggest cost economically may be felt abroad. I’m not talking about reinsurance here – though that is indeed an issue considering the estimated $5 billion damages bill – but about the disaster’s ramifications for the price of food and the price of energy: two issues that I see as defining for 2011.
Queensland’s floods may also be just the tip of the iceberg, so to speak, of a much larger weather phenomena that could in turn further exacerbate food and fuel inflation: a ‘super La Niña’ of a size and scope which, according to US meteorologist Art Horn, rivals the La Niña pattern of 1973-4, when Queensland and its capital city Brisbane last sank under a flood of today’s magnitude.
Horn's arguments on the current La Niña bear careful consideration not just because of the potential ramifications for global markets, but because they are being echoed by others from Neville Nicholls of the Australian Meteorological and Oceanographic Society to the always thought provoking John Clemmow of UBS, who discusses the Australian Bureau of Meteorology’s latest ENSO (El Nino Southern Oscillation) report. And, as Adam Mann discusses in Nature, conditions are likely to remain abnormally cool and wet in Australia, while windy and dangerous in North America’s hurricane belt for some months yet.
That doesn’t bode well for coal, of which Australia is the top global exporter, or for oil, of which a significant share comes from the hurricane-prone Gulf of Mexico and Caribbean.
When we consider the impact of other previous super La Niñas, whether in 1955, when epic floods stormed the Pacific North West and New South Wales, 1917, when the Ohio River froze over and the seeds of the 1918 pandemic were arguably sown, or as recently as 2007-8, when food prices reached previous records, the situation bodes even less well.
Simply put, a glance at La Niña’s previous appearances shows up a pattern of dramatic climactic risk, especially at a time when food and fuel are already commanding high prices. Figures from the UN’s Food and Agriculture Organisation, for instance, show that prices of staples are already higher than the peak in 2008, while both Nicolas Sarkozy as chair of the G-20, and World Bank president Robert Zoellick have put food prices at the top of the agenda.
Brent crude, meanwhile, is nearing $US100 a barrel on lower US stockpiles, a leaking Trans-Alaskan pipeline and unsure political situations in Sudan, Belarus and Lebanon.
And these are merely the supply-side issues of a weather phenomenon that cuts both ways. In terms of example, Bloomberg reports that heating oil futures are at a 27-month high on snowstorms in the US, while in China what Xinhua describes as the most extreme weather in ten years is adding impetus for further food price controls.
In India, meanwhile, there’s an onion crisis, Indonesia’s government is encouraging citizens to grow their own food, South Korea has released emergency supplies and deadly riots have broken out across the Maghreb.
But the issues, as it were, keep rolling in. The US Department of Agriculture has just released data reducing soybean and corn estimates, sending futures in those products to 30-month highs.
No doubt the Ponzi scheme of derivative trading, much of it cornered, is adding to the volatility of these commodities.
Yet you cannot argue that we’re seeing a bubble. On the back of Queensland’s floods, analysts from National Australia Bank are now expecting an increase in Australian fruit and vegetable prices of 30%, adding 75 basis points to the March CPI. This, alongside the blockage of Queensland grain ports – which comes in turn after estimates that half of Australia’s wheat harvest could be downgraded to fodder or milling grain – spells further chaos.
Amid dangerously accommodative monetary policy in the US and China, where the latter's M2 money supply has surged by some 20% in the past year, inflation matters dearly. As Patrick Chovanec from Beijing’s Tsinghua University's School of Economics points out, the recent fall in China’s CPI from 5.1% in November to 4.3% in December is a misleading indicator, due to the ultimately unsustainable retail food price crackdown and tepid cash rate measures. And as fellow expat academic, now securities strategist, Michael Pettis, writes this week, no lending quota – China’s de rigueur disinflationary measure – has yet to be set, much to everyone’s surprise.
China is caught between fuelling an economy based on cheap exports and fixed investment with arguable social returns, and the commodity inflation that this development model drives.
These concerns have been noticed by John Berthelsen and Benjamin Shobert, who respectively write that China faces grave social risks from food price inflation and food insecurity as a result of imbalanced economic policy, poor agricultural practices and the effects of climate change and deforestation. Shobert furthermore notes: “of the 13 major famines China has endured, six have been inexorably inter-related to political upheaval and conflict. China’s current leaders are aware of this part of their history,” he writes, “which is why the government’s stated goal of ‘95% self-sufficiency’ [in food supply] is deemed so critical.”
As much as the mainstream press likes to focus on China’s stranglehold of rare earth materials, the real danger in an era of trade wars and rising commodity prices is China’s dearth of food and fuel supply. China’s policy reaction to these challenges will be the ultimate determinant of whether the New Year ends in growth or ends in recession.
It is in this context, perhaps, that China has been spending so much money on its new J-20 stealth fighter plane, tested by the People’s Liberation Army as US Defence Secretary Robert Gates was meeting China’s civilian leaders in Beijing, and on its naval ‘string of pearls’ strategy. Both as a potent symbol, and as a latent weapon, China is acquiring the means to ensure commodity supply well into the future. Suddenly America’s foreign policy in the Middle East doesn’t look so unique.
Of course the only thing that China cannot defend itself against is the whims of the planet and it seems ironic indeed that the place from where climate changing coal was mined has now been inundated by epic flood. Following a Malthusian act of nature, highly combustible coal has been tossed onto the blaze of the world's growing commodity inflation.
And with La Nina still skipping coolly across the Pacific, more may be yet to come.
It would indeed be the ultimate black swan if La Niña pushed Chinese inflation into a cycle-busting inflation spike.
Flashman is a galavanting Australian poltroon working in the funds management sector.