Tuesday, June 17, 2008

Food Inflation Under the Microscope

Inflation in China is one of the big topics these days. China's consumer price index keeps registering significant inflation, especially in food prices. Is it really "inflation" or higher food prices that reflect market disruptions? The prices that have driven the inflation figures have stabilized over the last few months, but this won't show up in the CPI which only shows year-on-year changes. We can shed a little more light by looking at individual prices.

The two markets that have seen the biggest increases in prices are pork and soybean oil. These two price increases reflect mainly market conditions. Pork supplies in China shrank in 2007 due to disease and a massacre of hogs in 2006 due to low prices. Soybean and veg oil prices shot up for various reasons--soybeans lost area to corn, biodiesel demand in Europe boosted veg oil demand, China had a bad soybean crop in 2007 and China's rapeseed (the other main oilseed in China) production was down the last couple of years due to more planting of wheat and early rice.

Pork prices seem to have stabilized over the last few months, although they're not coming down. News reports say pork consumption is in a seasonal summer slump and supplies are gradually coming back. The earthquake didn't have much effect on pork production since the area that was hit doesn't produce that much pork. Prices are still about 50% above last year's price, and this is reflected in a roughly 25% increase in the meat portion of the CPI. If prices stay at their current level, year-on-year "inflation" will disappear by late summer (see chart below).

Cooking oil prices have stabilized too. The Chinese government has been out buying veg oil like crazy, building up stocks. It recently canceled the VAT rebate for veg oil exports even though it exports minimal amounts. Oddly, it cut the tariff on olive oil, an oil that is virtually unknown in China. In any case, veg oil prices peaked in March and are coming down slightly, although still 45% above last year and this is what shows up in China's CPI.

I don't have room to show all the prices. Admittedly there are a lot of prices that are still trending upward. Some vegetable prices are rising, but others fell after peaking during the winter storms in February. Beef and mutton are rising, but poultry is more stable.

Inflation is an across-the-board increase in prices. There do seem to be increases across a broad range of commodities, but some of the price increases were clearly results of microeconomic disruptions.

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