Could Rising Egg Prices Lead to a Chinese Market Crash?

Includes: CAF, FXI, PGI
by: Red Cat Journal

China's government recently announced further measures to control the rising price of some foods. Under the new measures, large producers of some foods (including dairy, pork, mutton and eggs) must seek government approval if they wish to raise prices. Wholesalers and retailers are under no such restriction, but must notify government officials of price changes when they reach certain levels. The price controls are meant to be a temporary measure.

China has been targeting asset price inflation (and perhaps food price inflation) through tighter monetary policy. Food price inflation is different than property price inflation because food prices affect the poor the most, given that food costs account for a higher percentage of the poor's income. As a result, food prices are a major concern of China's large rural population, where property bubbles in Shanghai or Beijing are not.

Another potential difference is also of great importance and that is: are the sources of price inflation in food and property the same? In another article, the Red Cat Journal argued that China's property prices are rising due to money supply growth. Are food price gains due to the same phenomenon? Whether this is the factor at work in rising food prices seems a bit more difficult to fathom. For one, difficulties in food production, such as disease outbreaks among pigs, have hurt food supply. For another, rising income levels in China are leading to demand for better and more food.

Understanding the source of food price inflation in China is critical to getting a handle on the solution. Food price controls are not the long-term solution and it is a good sign that China's government says they are temporary. Suppressing prices could lead to food price shortages as producing more food actually leads to lower profits, not more, if prices are below that determined by the market. In this case, producers will be incentivized to reduce food supply, rather than increase it.

If the source of food price inflation is a true demand-supply imbalance, then China must work hard on finding ways to increase the food supply, either through technology, better use of resources or through increasing imports. If the source of food price inflation is monetary policy, then tighter monetary policy is the answer, putting even more pressure on China to clamp down on credit and money growth. A stock and property market crash may be the unfortunate side effect of sparing the country-folk from famine.

Disclosure: none