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.


The Lorax said...

Finally, someone makes the link between climate change, the great flood, and coal mining. Perhaps Mother Nature is simply taking some self-correcting action?

It never ceases to amaze me how many left-leaning economic commentators are one minute lambasting the government for not putting a price on carbon, and the next cheering on our dirt-based economy (and by implication our coal exports). Peter Martin and Gittins spring to mind. What powers of denial and self-delusion must they possess?

Sam Brown said...

La Ninas will dominate summer weather patterns on the east of Australian for many years.

La Nina occurs when colder than average sea temperatures in the Pacific combine with stronger winds and increased cloud density to alter weather patterns in Australia.

La Nina and El Nino events are clustered avery 10-40 years (not random) and the previous run of La Ninas hapened between the 40s 70s (and ended with the floods of 74). They were followed by around 30 years of dry El Nino patterns.

We will see much wetter summers and greater flood risks from Rockhampton to the NSW central coast for the next 30 years. Even though La Ninas usually dissipate by April-May, intervening months can still bring monsoonal rain to soaked catchment areas.

This return to La Nino cycle will have a devastating impact on Australia, worse than last time due to increased population density in the affected areas. It's likely we face 30 years of extreme La Ninas weather events.

Sam Brown.

Australian House Price Crash - The Blog

David Llewellyn-Smith said...

Good to see you back, Lorax. Holiday?

The Lorax said...

I have primary school age kids, so this is a very busy time of year. Only two more weeks!

Anonymous said...

Good post - food for thought. Have been following Bear Feller's musings for a while now, he too has an interest in food inflation (and various other geopolitical risk issues). Well worth a look.

Was it Naked Capitalism that had a longish piece recently on cloud seeding, the increased use of the practice by the military and concerns as to the effects on long term global weather patterns?

Finally, South Western Australia is experiencing some of the hottest, driest conditions on record - not all Australia is drowning in monsoonal conditions. El Nino perhaps?

Anonymous said...

Much press about 10 people dying in qld.
You guys have been so busy moaning about this that you didn't notice that Brazil had floods this week too? 250 people dead so far...

Anonymous said...

@The Lorax
Perhaps Mother Nature is simply taking some self-correcting action?
Mother Nature is the Fat Lady?

What powers of denial and self-delusion must they (economists) possess?
Denials of ecological limits resemble anosognosia (inability of stroke patients to recognize their paralysis).


Anonymous said...

Brazil did get on the news here if rather briefly.

Bruce Krasting said...

You are correct that an extreme La Nina is responsible for the wacky global weather of late. The good news is that the cycle peaked in December and we are now reverting to more neutral conditions.

NOAA has an excellent graph that tracks this. Look at how steep this La Nina is. Look also how it compares to the 73' event.

Hang in the Australia (and many other parts of the world) better weather is coming.

Got A Watch said...

Sympathies from Canada on the floods. Great Blog btw, found it from link at 'Naked Capitalism'. Good work mates.

Let's hope La Nina is waning, as Bruce says, but it seems a bit early to me, it just got going, didn't it? I'm not a weather expert, so I really can't say.

A friends Blog in the US, Inside the Hive has been covering the floods extensively, with reports from Aussie friends.

Best wishes to Australia, and hope that you can bounce back quickly. It's snowing here in Canada, and will be -20 C tonight, so everyone has weather issues. Damn weather, it seems to happen every day.

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