Keep an eye on China as we watch another week of grain price surges. The most dramatic impact of the soaring prices for corn and soybeans in particular will emerge there first. Months after a surge in food price inflation in 2011 saw the Chinese authorities slow the economy to cut price pressures and control housing prices, the country is facing the growing possibility of another destabilising bout of inflation. And the US drought will be to blame.

Last week saw soybean futures prices on the Chicago Board of Trade for August delivery set a record high of $US17.7775 a bushel, September corn jumped to a record $US8.2875 a bushel, and September wheat jumped 8.25 cents to $US9.4475, a new four-year high. That left corn futures price up 56% and soybeans up 28% since mid-June. Wheat futures are up 49% in the same time frame.

The price pressures will continue tonight ahead of the weekly update on the state of the US grain crops tomorrow (6am), our time. On Wednesday the US Department of Agriculture will release an update on its outlook for US food and inflation data, which will contain the first official estimates on the likely impact for US consumers of the drought and price surge. There will be another progress report on the condition of US crops next Monday, another on August 8 and then the big monthly crop on August 10 that will see the size of the corn and soybean crops slashed, and a reduction in the size of the late wheat harvest estimate.

A repeat of 2007-08 shortage and food riots is not expected this year, despite the price rises, because the US winter wheat harvest is all but finished and good crops are still expected in Australia and in parts of EU. As well, rice stocks and harvests are in good condition. But many analysts have ignored a very important spinoff of the price surges, the impact on China where the soaring price of corn, soybeans and soy-meal has definite inflationary dangers. Food prices account for nearly one-third of the weighting in the calculation of the the Chinese consumer price index, so the transmission of any sharp increase in food prices is quick.

In this case, the rise is likely to be slow as the big price rises have only happened in the past six weeks. But the droughts in Argentina and southern Brazil did push soybean prices higher from February.

Regardless if there’s rain in the US drought hit areas in the next month, the reality is that there is going to be far fewer soybeans to go around in the coming year. The US drought and those earlier dries in Brazil and Argentina mean consumers everywhere will have to pay more for them. And the most dangerous impact is in China, which has just recovered from a bad bout of food price inflation. While China’s staple is rice, which is not affected by the US drought, soybeans and corn are used to feed its livestock, especially pork and poultry.

Higher prices for both will translate very quickly into high food prices and therefore inflation. Food is still a large share of Chinese consumer spending , and as we have seen off and on since 2007,  is politically very sensitive.

Consumers can replace soya oil with edible oils from other plants such as rapeseed/canola or sunflowers or peanuts. But compared to the sheer volume and availability of soybeans, these alternatives can’t be used to any great extent to offset the price surge, especially in feeding livestock.

So the longer the US drought goes on, the higher soybean and corn prices will rise, adding to the pressures in China. Chinese authorities will have to respond (after all this is changeover year for the leadership and food riots won’t be a good look). So will the government order a new tightening of monetary policy, soon soon after cutting rates twice in a month to ease the crunch? Or would they risk rising food prices that would force Chinese consumers to cut their non-food consumption at a time when such spending is being encouraged? That could see more food price subsidies to compensate for the price rises.

The previous surge in inflation was caused by a shortage of pork caused by disease and slaughterings, which reduced herd numbers and supply until new animals had grown to sufficient size to come to market.

China has been buying more grain from the US especially this year. China imported 5.62 million tonnes of soybeans in June, up 31% on June of last year and up from the 5.32 million tonnes imported in May. That was a seven-month high as prices, already boosted by the droughts in Brazil and Argentina, started accelerating as news of the impact of the US drought on plant condition and probable yields started spreading.

Helped by the double-digit rise in world oil prices since mid-June, the surge in the prices of grains and oil seeds has reversed the slump in global commodities that saw some analysts wondering about the chance of deflation and tough times to come in 2013. The Thomson Reuters/Jefferies CRB Index  one of the leading measures of global commodities markets, had fallen to 18% below its peak of the year (that was in mid-June), now it’s down just 0.2% year to date, and up over 8% for July so far.

Peter Fray

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