Saturday, October 16, 2010

China's Would-Be Price Makers

Like other commodity prices, edible oil and oilseed prices are rising, and Chinese officials are getting worried.

An article from the Dongfang Daily newspaper reports that edible oil prices have been rising since this summer. Futures prices have reached their highest level since the 2008 financial crisis.

Upward pressure has been building this month after the National Day holiday. At a Shanghai wholesale market, the price of one type of soy oil went up from 164 yuan per box to 180 yuan this month, and Jinlongyu mixed oil went from 210 yuan to 225 yuan/box. The Shanghai grain and oil industry association secretary Zhao Zhiwei said Shanghai supermarket prices for 5-liter bottles of soy oil went up about 6 yuan this month.

Several factors contribute to rising edible oil prices: the rising cost of imported soybeans since July, buildup of inventories ahead of the peak season, and a general upward trend in commodity prices and inflationary expectations.

Against the background of rising oil prices, the government has announced that it will sell 300,000 mt of rapeseed oil from reserves on October 20th.

Mr. Zhao, the Shanghai grain and oil association secretary, thinks the government is paying a lot of attention to this. With state inventories plentiful now, the government will use measures to control the price.

According to reports, since 2008 Sinograin (the government's reserve management company) has accumulated about 2 mmt of edible oil in reserves, reported to be about 10% of world consumption. And they also have put 1 mmt of soybeans in reserve that they could sell into the market.

[In other words, part of the huge demand for oils and oilseeds in China over the past year reflected purchases that were stacked in warehouses, not consumed.]

Can the government stop prices from rising? Analysts quoted in the article say such reserve sales can even out short-term fluctuations in prices, but the government can't stop a long-term rising trend in prices since China is highly dependent on imported edible oils. Those prices are set in the international market and can't be controlled by Chinese officials.

As the rest of the world trades more with China, the view of price is becoming a major source of conflict. See the exchange rate conflict--an exchange rate is the price of a currency--Chinese officials don't think it should be allowed to fluctuate even when there is a massive increase in the supply of dollars that should drive its price down. Chinese officials have a similar view of ag commodity prices. Official policy documents explain that grain prices should rise in a steady, gradual manner year after year.

Who sets prices? Are they set by an impersonal "market" or by government officials?

What is the role of a price? Is it just an accounting convenience or is it a reflection of a commodity's scarcity?

Why do prices fluctuate? Is it because of changes in supply and demand, or manipulation by big companies and speculators?

Chinese officials, obsessed with control and organization, don't trust "the market." "The market" is chaotic and out of control--the antithesis to the Chinese Communist Party's approach--"the market" can't be trusted to set "reasonable" prices.

Prices are never right for Chinese officials. They are either too low for farmers to have strong incentives, or they are rising too fast and creating inflationary expectations.

Edible oil is a particularly vexing problem since China is heavily reliant on imports. As the rhetoric from Chinese officials lately has emphasized, they think world grain prices don't have much effect on the Chinese market since imports are such a small share of the market. The weak link is the edible oil sector where prices are set in world markets. If officials try to control grain prices, fluctuations in oil and oilseed prices create big distortions in relative prices.

In the hubris of the first half of the 20th century, "scientific" socialists thought they could use big mathematical models to plan the economy and make sure supply and demand were balanced. While China was busy with its political upheavals and studying engineering, the rest of the world discovered that socialism and price controls don't work (a lesson quickly forgotten). Now China and the rest of us will have to discover this all over again.

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