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La Niña as Black Swan – Energy, Food Prices, and Chinese Economy Among Likely Casualites

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Reader Crocodile Chuck highlighted an important post at Houses and Holes, an economics-oriented Australian blog. While Australia is reeling from the immediate impact, the broader impact of 2010-11 weather patterns may have much bigger ramifications for food and energy prices in Australia and abroad.

The post focuses on the possibility, increasingly endorsed by top meteorologists, that the heavy Australian rains are the result of a super La Niña, the last of which was seen in 1973-4,the time of the last severe flooding in Queensland. Super La Niñas are hugely disruptive to agricultural production and can have other nasty knock-on effects (some contend the 1917 La Niña helped spawn the 1918 influenza pandemic).

In this case, the damage of a super La Niña will not only increase food costs at a time when price rises and food scarcity are already a major concern, but will likely extend to energy prices as well. That one-two punch would be particularly devastating to China.

In Australia, fruit and vegetable prices are projected to increase 30% this year as a result of La Niña. And recall Australia is a major agricultural exporter, so production shortfalls there will hit other markets. Super La Niñas tend to impair food output overall. 2007-8 saw a borderline super La Niña, and we saw sharply higher food prices in the first half of that year. Note that the UN’s Food and Agriculture Organisation reports that staples are already more costly than at any time in 2008.

Similarly, energy markets are already showing signs of supply pressure even before possible weather effects, namely, more and more intense hurricanes in the Gulf and Caribbean reducing oil output, in addition to the expected decline in coal shipments out of Australia.

The effects of adverse weather patterns will be amplified by bad policy choices. Jim Quinn has a solid post up on the disastrous ramifications of US ethanol policy. This program is absolutely hairbrained; it was roundly denounced in 2008 as being an environmentally costly and inefficient way to augment energy supplies. The only type of ethanol that is a net plus when all the environmental impacts are considered (water usage, effect of taking land out of food production on agricultural prices) is Brazilian sugar-based ethanol. But we’ve decided to impose a 54 cent tariff on that. As Quinn tells us:

The United States is the major player in the world corn market providing more than 50% of the world’s corn supply. In excess of 20% of our corn crop had been exported to other countries, but the government ethanol mandates have reduced the amount that is available to export.

This year, the US will harvest approximately 12.5 million bushels of corn. More than 42% will be used to feed livestock in the US, another 40% will be used to produce government mandated ethanol fuel, 2% will be used for food products, and 16% is exported to other countries. Ending stocks are down 963 million bushels from last year. The stocks-to-use ratio is projected at 5.5%, the lowest since 1995/96 when it dropped to 5.0%. As you can see in the chart below, poor developing countries are most dependent on imports of corn from the US. Food as a percentage of income for peasants in developing countries in Africa and Southeast Asia exceeds 50%. When the price of corn rises 75% in one year, poor people starve…The 107 million tons of grain that went to U.S. ethanol distilleries in 2009 was enough to feed 330 million people for one year at average world consumption levels…

The amount of grain needed to fill the tank of an SUV with ethanol just once can feed one person for an entire year. The average income of the owners of the world’s 940 million automobiles is at least ten times larger than that of the world’s 2 billion hungriest people. In the competition between cars and hungry people for the world’s harvest, the car is destined to win. In March 2008, a report commissioned by the Coalition for Balanced Food and Fuel Policy estimated that the bio-fuels mandates passed by Congress cost the U.S. economy more than $100 billion from 2006 to 2009. The report declared that “The policy favoring ethanol and other bio-fuels over food uses of grains and other crops acts as a regressive tax on the poor.” A 2008 Organization for Economic Cooperation and Development (O.E.C.D.) issued its report on bio-fuels that concluded: “Further development and expansion of the bio-fuels sector will contribute to higher food prices over the medium term and to food insecurity for the most vulnerable population groups in developing countries.” These forecasts are coming to fruition today.

The Houses and Holes post teases out the implications of higher fuel and food costs for China:

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…

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.

Memories of food riots in developing economies in 2008 have largely vanished from the consciousness of most Americans. Yet have food riots in the Maghreb and some governments are already implementing emergency measures. Few seem to be factoring the risk of food shortages and resulting political instability into cheery forecasts for 2011.

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35 comments

  1. mannfm11

    The level of malinvestment in China is going to catch up with it. From what I understand, China has historically been plagued with violent revolution and the government could have a mess on their hands over there. As much as their foreign reserves dominate the headlines, they won’t go far if there is a run on hot money. If food becomes a problem, they might wish they had not put all those empty buildings on that nice farm land.

    As far as the ethanol is concerned, I have thought it was one of the crimes of the last decade, putting our food supply and indirectly our farm land into the tanks of automobiles. The recession bared this scheme to be what it is, a Wall Street scheme to leverage income. The money was made by Wall Street and the losses taken by humanity in general. From what I have read, the best biofuel in the US is hybrid tobacco, but they are trying to find an excuse to get rid of it. High sugar, high protein, 20 tons an acre.

    1. Ignim Brites

      Cannot blame everything on Wall Street. The ethanol policy was an invention of the pc crowd.

          1. ozajh

            I totally disagree. Purely as a meme it’s TREMENDOUSLY useful.

            After all, it allows the ‘business as usual’ lobbyists to go on their merry way.

      1. Paul Tioxon

        The Brazilian ethanol program has produced a net retention of wealth by that country since initiated in 1975, after the Arab Oil Embargo, in retaliation for our support of Israel in the 1973 Middle East War. Since then, in addition to 100% ethanol filling stations as part of national fueling infrastructure, they have found oil off shore, which will also contribute to their national wealth. But more importantly, they have shown through decades of trial and error, how not to disrupt their food supply. The major supplier of ethanol is the proud sponsor in this country of the Indianapolis 500, providing every single race vehicle with nothing but ethanol to run their race. It is also the sole fuel for all of the other racing events in that circuit, except for one sponsored by the Iowa Corn Ethanol producers. I am so glad there are the reactionary blurbs from the token pseudo intellectuals from the right (pc crowd). But your position has been exposed and discredited by events throughout the world. The Brazilian government has done what the US government has failed to do, become essentially independent of the oil cartels for fueling their economy. Hardly a pc inspired goal.

      2. ChrisTiburon

        “PC” AKA “Politically Correct” in its true meaning which is “Pro Corporate”…time to use that to take the wind out of the sails of the socially suicidal simpletons.

  2. David

    I would be surprised if the increased costs for Australian fruits and vegetables is only 30%. I recall bananas costing about $7 a pound a few years ago when North Queensland was hit with flooding a few years ago. It took most of a year before prices returned to normal.

  3. leroguetradeur

    My Australian friends tell me that La Nina has already had a far more catastrophic effect on the nation than this.

    It is the sole cause of utterly disastrous warm wet humid weather, and this in turn is the sole tragic reason why the finest cricket team in the world has lost a Test Match series by a dreadful, a catastrophic, a humiliating margin to one of the worst teams in the world, a bunch of whingeing Poms, and now the proud Australian people are being subjected to the appalling spectacle of this team parading through their streets in triumph.

    There are reports of grown men adding to the dreadful floods in Queensland with their tears.

    1. Campbeln

      Hey! We won the 20/20 by 2 runs against the Poms this weekend, didn’t we?

      Oh, and Cricket: More boring then baseball, slightly boring then watching grass grow (though that is a bit part of the DAY ;)

      Cn

  4. Max424

    YS: “Few seem to be factoring the risk of food shortages and resulting political instability into cheery forecasts for 2011.”

    What do street wars and coups and third world beggars have to do with our holy and anointed mother Dow? The answers are: zero, nada, and zilch!

    Let go of the part of you that is Ruppert and Kunstler, and thoughts of Dow six thousand, and quantitatively embrace your inner-Bernank, and dream only bullish dreams.

  5. Jim Haygood

    ‘The recent fall in China’s CPI from 5.1% in November to 4.3% in December is a misleading indicator.’

    … as is the preposterous claim that U.S. food costs rose a barely detectable 0.1% in December, and only 1.5% for the year.

    http://www.bls.gov/news.release/cpi.nr0.htm

    I’m not engaging in hyperbole when I claim that U.S. inflation statistics are a flat-out Soviet-style lie, intended more to conceal the rot devouring the foundations of the empire (and to minimize COLA costs) rather than to impart information.

    Despite the U.S. recovery being an adolescent in terms of typical duration, crude oil is already approaching a level which could snuff it out prematurely.

    QE2 is all about creating inflation. And it’s a ridiculous myth that the Fed has a control dial, like the heavy lathe-turned metal volume knob on a high-end audio amplifier, to fine-tune inflation into a tight 1-2% band. Utter nonsense! When inflation catches hold, you’ll hear an audible Whump! like the flashover in a house fire which dooms the structure in an awful instant.

    Globalism means that inflation feeds through everywhere. The purblind Fed is simply ignoring runaway commodity price indexes, as Bensane’s unsinkable QE2 ship of fools sails majestically on into the icebergs. Let them eat Sno-Cones!

    1. john

      Agreed. As I was falling asleep last night, I wondered what the CPI is excluding the “volatile” sectors — food and energy, sure. What about implied rent? Or just take out housing and what’s the inflation rate over the past three years?

  6. rjs

    excerpt from my weekly emailed summary:

    commodities were in the news again this week, especially food & energy, elements which the Fed believes it can ignore in the measures of inflation they track when setting monetary policy…the headline news that drove corn and soybean prices to new cycle highs was a report out of the USDA revising the estimates for the feed & grain crops in the US & worldwide; prices of both jumped 4% when the report was released, with corn futures up 94% from their lows, soybeans up 51% and wheat up 80%…the worldwide supply deficit of wheat, already impacted by the russian fires and pakistani floods this summer, has gotten worse, as virtually the entire winter wheat crop in australia was destroyed by widespread flooding over most of the arable part of the continent…there were food-price related riots in tunisia, algeria, morrocco & mozambique, and the Indian cabinet met in a special session to consider how to deal with the rising price of onions (much to my surprise, ive learned that two previous indian goverments were toppled by unrest over onion prices; similar situations exist in sri lanka with dependence on coconuts, and indonesia with chili peppers) the financial times is covering the global food crisis in depth with dozens of articles, but since FT is a pain in the butt to copy ill just link to it here http://www.ft.com/foodprices the energy price rises were attributed to cold weather, as heat oil ended the week at a 27 month high and brent crude in europe touched $99 dollars, but possibly contributing was the shutdown of the aleyska pipeline, 12% of our domestic supply, due to a leak…riots over fuel prices were reported in bolivia & chile, with two deaths in chile…the US dept of Energy forecast that gasoline could top $4 gallon again this summer; curiously, this all followed an forecast early in the week by the US EIA that oil would hit $99 by the end of 2012…

    after the year just past saw the worst heatwave in russian history, once in a century heatwaves in a dozen other countries, and once in a century flooding in pakistan and elsewhere, both NOAA & NASA released data showing that it was indeed the wettest year in history, and tied 2005 for the hottest year ever…meanwhile, the once in a century flooding in australia continued with more heavy rains this week, and an area of the country bigger than texas and california combined was declared a disaster…there was also once in a centruy flooding in brazil, with a death toll well over 500 making these rain caused mudslides brazil’s worst weather related disaster in history…an international study concluded that a meltdown of greenland is now close to inevitable, and a canadian study predicted that the results of greenhouse gases already in the atmosphere would result in warming that could not be reversed for centuries…

  7. Bruce Krasting

    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.

    http://www.esrl.noaa.gov/psd/people/klaus.wolter/MEI/

  8. Nobody

    These unending attacks on US corn ethanol program are completely missing the point. The point of contention of the global trade talks and free trade area of Americas has been always about Western farm subsidies. The third world was always protesting the Western practice of dumping its agricultural surpluses onto the global markets destroying farmers in developing nations. As a matter of fact, just a few years ago the WTO was on the verge of authorizing countries including some third world producers to slap punitive sanctions against US exports in retaliation for corn export subsidies http://goo.gl/5UmiW. The corn ethanol program has saved the US from a major trade dispute.

    It did not save the US from another dispute, however, during which the WTO authorized Brazil to retaliate against US cotton export subsidies which Brazil duly slapped on the US exports at the beginning of the last year http://goo.gl/2ZqHs. If there was any common sense left in that country, the scandal would have been about why the US government does not use its ethanol program to switch cotton growers to growing biofuels as well. This food vs fuel debate just does not make any sense when the US government keeps wasting billions on export farm subsidies amidst escalating WTO disputes.

  9. Tenney Naumer

    It is not at all correct to blame this particular La Nina, which is NOT a super La Nina — the real culprit is two-fold, and the La Nina has exacerbated the situation:

    (1) sea-surface temperatures around Australia have been relentlessly increasing over the past 4 decades — see this graph from the Australian Government Bureau of Meteorology:

    http://www.bom.gov.au/cgi-bin/climate/change/timeseries.cgi?graph=sst&area=aus&season=12&ave_yr=11

    (2) global average temperatures have never been hotter, leading to an increase of 4-7% more water vapor in the atmosphere, and what goes up must also come down.

    Without a La Nina, this extreme precipitation event most probably would not have occurred, but a strong La Nina coupled with the above two factors was just a disaster waiting to happen.

    More such extreme precipitation events will probably impact the U.S. once the next El Nino takes hold and things really get hot all over the planet.

    1. TDK

      This gets to the heart of it, which makes you wonder why anyone is calling this a Black Swan. Extreme weather events are not individually predictable, but an increase in such events has been predicted for at least a decade.

  10. Hugh

    Agribusiness conspires with Congress to jack up the price of corn. Yet ethanol is so uneconomic that it requires large subsidies on top of this artificially created scarcity. So not one but two points of looting there.

    I am sure natural disasters do play a role but this has to be seen against the background of financial speculation in commodities more generally, a third point of looting.

    The result is political instability, increased poverty, and starvation. Kleptocracy is not a victimless crime. It kills people. Its practitiones aren’t just thieves. They’re murderers. They may wear nice suits and pull down huge bonuses but they are covered in blood.

  11. Jim Haygood

    It’s not official till it’s officially denied:

    Jan. 16 (Bloomberg) — Chinese President Hu Jintao rejected U.S. arguments that allowing the yuan to appreciate against the dollar would help the government in Beijing tame inflation.

    The Chinese president said his government is fighting inflation with a package of policies, including interest rate increases, and that rising prices can “hardly be the main factor in determining the exchange rate policy,” according to a transcript of the answers.

    He said the increase in the cost of living is “on the whole moderate and controllable,” according to the transcript.

    http://noir.bloomberg.com/apps/news?pid=20601087&sid=a2uSEYBUhSWw&pos=5

    It’s understandable that having gotten its exporters hooked on the seductive competitive edge of a pegged exchange rate, China is loathe to change it.

    But refusing to do so just means the adjustment will occur via painful increases in internal (yuan) prices.

    Sharp hikes in Chinese minimum wages hint that the authorities are worried about social unrest. An overhang of property speculation threatens investor unrest, while the Tunisian revolt underscores the tensions which underlie ‘socialist democracies.’

    I see a rhyme with Tiananmen Square, 1989, after China’s massive boom of 1982-1988 overheated:

    1989-91 — Growth slowed after the [Chinese] government braked the overheating economy following an aborted effort at wholesale price reform in 1988 which resulted in panic buying and runaway inflation. Price stability was achieved by cancelling large fixed investment projects, slowing domestic demand.

    http://www.chinability.com/GDP.htm

  12. WileEC

    It’s funny to me that if only 2% is corn grown for “food products” and 42% is livestock feed corn, that a far simpler solution to corn supply would be for Americans to eat less meat and dairy. Is there something wrong with a goal that promotes better health, lower health expenses, and helps solve an energy issue?

    1. Yves Smith Post author

      I said a while ago (2007?) that we all need to eat further down on the food chain. Beef is horribly costly in terms of how much grain it takes to produce a pound of beef. Chicken, by contrast, is very efficient as far as animal proteins are concerned.

      1. Paul Tioxon

        You know, I went through these discussion 40 yrs ago with “Diet for A Small Planet” and other books analyzing the net cost of protein grams and calories. But I guess everything that is old comes back in some sort of cycle of eternal recurrence. And some people I wish would just go away. Gee, I hope that’s not vitriol!

  13. Alison

    Thanks for this article. But I would add to your super la Nina phenomena a wall of money buying commodity ETFs and paper money in the agricultural products space. The recent scandal over the global price of cocoa and those who attempted to manipulate or connoer the market is just the tip of the iceburg.

    It is interesting to note that the price of soy collapsed along with the price of crude as the markets deleveraged. Global demand is real to be sure. But along with walls of water in Austalia and fire and heatwaves in Russia, we can see global institutional investors loading up on their “commodities as an asset class” for profit and inflation hedges.

  14. Tenney Naumer

    Here’s the thing — extreme weather events are going to continue to increase over time since we are doing nothing to reduce the level of CO2 and CO2 equivalents in the atmosphere.

    We’re going to see more extreme droughts, extreme precipitation events (both rain and snow), extreme winds (super down bursts, hopefully not like the 3-day event that occurred in 2005 that knocked down one-half billion(!) trees in the Amazon), and weather whiplash that wrecks havoc with farming all over the world.

    And forget us all moving to Canada or the Canadians being able to put more land under agricultural production — have you seen this wonderful farm land in Canada just waiting to be tilled once those horrible glaciers disappear and the permafrost melts? We are talking a bunch of rocks or mushy swamps, with uncertain seasons.

    There are some short-term solutions, but how to put them into action is your guess — stop throwing away so much food in the U.S. would be a good start. In developing countries, get into place distribution systems that will prevent so much spoilage before the products get to consumers.

    In fact, there are so many ways to improve production and reduce waste that people have written books etc.

    But, so long as we have huge agri-business corporations running rough shod over everything they touch (Bayer selling pesticides toxic to bees comes to mind), we are going to be heading over a cliff.

  15. tinbox

    With all due respect…this post and most of the comments do not display much knowledge of the current state of the ethanol, gasoline, and sugar markets.

    Just for your guide, assuming that gasoline and crude oil are subsidy-free will lead to large errors. Not noticing that sugar is over 30 cents/pound will lead to large errors. Assuming that feeding livestock is sacrosanct is just bizarre.

    By the way, the main opponents to ethanol production and consumption are the parties that lose sales: petroleum companies.

    1. Yves Smith Post author

      With all due respect, it’s cheap and easy to criticize, and I see you make no comments that are at odds to the thrust of the post. Did you read Quinn’s piece, which does discuss subsidies at some length? And what do US sugar subsidies have to do with the efficiency of Brazilian ethanol, which was the only reference to sugar in the piece?

      1. tinbox

        The thrust of the piece is that ethanol production is a government induced market inefficiency (in keeping with his blog’s Ayn Rand-lovin’ theme). To make that argument, Quinn makes the assumption that US Gov’t subsidies are zero-he only enumerates the subsidies to ethanol (some of which are ludicrous). Everybody who looks at energy subsidies quickly realizes that fossil fuels, not alternative energy, are by far the largest beneficiaries.

        As far as the environment and ethanol, I can only assume that Quinn somehow missed the BP/Macondo news this summer.

        And on the sugar topic, I was not referring to sugar subsidies, but to the relative economic merits to sugarcane producers of refined sugar vs. ethanol. At 30 cents/pound for non-US, world market, refined sugar vs $2.40 for ethanol, everyone would rather make sugar. Right now, corn is far and away the cheapest source of ethanol. Not Brazilian sugarcane, US corn.

        The CME puts out a great statistical report on ethanol weekly; page 14 shows the economics of sugar-produced ethanol.
        http://cmegroup.barchart.com/ethanol/

  16. 60sradical

    Over 40 yaers ago I read 2 interesting articles in just one edition of the Los Angeles Times. The articles were juxtaposed and each had a different writer. Article one discussed the absolutely unbelievable fact that all countries on earth will spend about 1 Trillion dollars on military defense budgets over the next decade(that would’ve been about 1967-1977). This was in the late 60s and seemed incredibly sad and insane, since the war in Viet Nam was an ongoing needless slaughter. Article number two discussed, from a scientific point of view, how just several key grain growing area in the midwest, if turned over to non-profit engineering corps., with cutting edge machines, efficient robotic watering,computers, etc., could feed THE ENTIRE WORLD!
    Right then I realized I was a character playing an existentialist role as “the absurd man” in some avant-garde French movie being filmed in Southern California. I knew the military budgets would continue to rise. And I sure as hell did not expect humans to get together to solve the human problem of endless starvation–even though such simple tactics stared them in the face. I had spent 2 years livng in dire 3rd world conditions. I had a feel for realpolitik. It was Absurd(cf., Camus), because I felt there was no hope. Yet, I must act.
    This is our human condition-like it or not. So struggle for the truth and reach for solutions, hopelessness notwithstading.

  17. emca

    I can’t help but wonder, given U.S. dominance in agricultural production, what will happen when weather again turns the corner.

    Hybrid corn is such a fragile crop, pests abound, bloated in extreme with a rapacious appetite for food and water.

    This recent column and quote

    “With the lowering of corn yield and very low stocks numbers, “there is going to have to be a rationing process taking place in corn.”

    Not sure what rationing entails in agriculture, but it doesn’t sound anything like a demand-supply normality leading to lower prices.

    Incidentally, water requirements of corn are explored in this 2007 article:

    It takes a lot of water to grow a corn crop:

    All you care to know about corn and moisture requirements, but were afraid to ask.

    “Think about a 160-acre cornfield irrigated with only 10 inches of water. That would take more than 250,000 gallons per acre, or some 40 million gallons for the field. So switching to irrigation isn’t a little thing.”

    Corn is a thirsty beast and without its take, it folds and withers…

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