Tuesday, June 3, 2008

Pigs Eat Wheat

Usually, wheat is more expensive than corn in China (and most other places). Wheat mostly is ground into flour for making bread and noodles while corn is fed mainly to animals. Presently, the usual price relationship is reversed—corn is now more expensive than wheat. A report on China’s feed industry (www.yumi.com.cn) this week noted that feed mills in northern China are paying RMB1690/metric ton for corn and RMB1670/mt for wheat. In past years—before 2006—corn was typically about RMB200 less than wheat.

Chinese feed mills, looking to minimize their costs, are adjusting their feed recipes to use a higher ratio of wheat to corn. The report says mills are generally replacing about 20-40% of corn with wheat, and in parts of Shandong Province (a major wheat-growing area where demand for corn to make starch is booming) half of the corn is being replaced with wheat. Moreover, the new harvest of winter wheat is about to happen, which usually brings on a seasonal decline in wheat prices, pushing prices even more out of whack and encouraging feed mills to substitute even more wheat for corn. Thus, the report predicts that this wheat substitution will soften demand for corn even though feed demand is expected to surge, keeping a lid on corn prices.

This is a reminder of the power of price. Even in one of the last self-proclaimed “socialist” countries, prices convey vital information about the economy—where resources are needed and where they are abundant. When corn is scarce and expensive, feed mills cut back on corn and substitute wheat. This ensures that the surplus wheat spilling out of warehouses gets used up faster (instead of rotting or serving as rat food) and scarce corn gets conserved.

Most people tend to think of the economy like engineers—that things are always produced according to fixed recipes. For example, an often-cited “statistic” is that it takes 7 lbs of grain to produce 1 lb of meat. Therefore (so the story goes), if every Chinese citizen increases his/her meat consumption by 1 lb, China will need 7x1x1.3billion=9.1 billion lbs. of additional grain. Then someone has to requisition that grain from somewhere and make sure it gets to where it needs to be. This is the engineering mentality that created the tragedy of central planning during the “scientific” 20th century.

There are many recipes for animal feed. The 7:1 grain-meat ratio is for beef feedlots in the Midwestern U.S. where they send cattle for their last few weeks of life for an eating binge to fatten them up for the butcher’s knife. This kind of animal feeding is virtually nonexistent in China where grain has traditionally been a lot more expensive than in the U.S. Grain makes up less than half of feed given to Chinese livestock. Farmers make use of other feeds that are abundant and cheap. One major source of feed is the bran and husks left over after threshing and milling wheat and rice. They also use by-products from making corn starch and ethanol as well as potatoes, vines, vegetables, and table scraps. In China it takes about 3 lbs. of grain to produce a pound of pork and about 2 lbs or less for a pound of chicken or beef. Grain consumption by animals in China is not exploding like many newspaper columnists, bloggers, and even MIT professors think it is, because Chinese farmers conserve on grain when it gets expensive.

Economies are much more flexible than most people realize. People like to think of economies as being like a machine, but an economy is more like an organic being. Different parts are always changing, growing, interacting, and sending messages to each other. Sometimes new parts grow; sometimes unneeded parts die and drop off, leaving the rest of the body with more resources to grow stronger.

There are many recipes for producing things and the recipe can be adjusted with incredible speed based on what ingredients are plentiful and which are scarce. Prices are like messages sent through the nervous system at lightning speed with instructions to buy/sell/conserve/binge whatever is in abundant/short supply. Don’t be fooled into thinking we’re going to run out of this or that. Prices will send the right signals—as long as governments don’t cut the nerves with misguided policies like price controls or subsidies.

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