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Why China had to negotiate with Trump

By Michael Knox - posted Thursday, 24 October 2019

In a previous commentary on China, I started with the rather obvious point, often neglected, that China is run by the Communist Party of China. The way the Communist Party sees the world is in terms of historical progress outlined first in Marx and second in Lenin.

Right now, they see themselves living through the period described by Lenin in his "Imperialism: The Last Stage of Capitalism". In simple English, this means that they intend to rule the world and don't intend to be nice to anyone. Their bargaining position is that they will only make decisions regarding international negotiation not because they are attempting to establish trust or be generous to anybody but because they have to for structural reasons in their own economy.

The tentative agreement between China and Donald Trump emphasises that there are two short term structural problems within the Chinese economy which the Chinese leadership is attempting to address. One of those is in the food markets and the problem with food inflation, and the other is in the capital market; the increasing problem that China will have in financing its current account.



I'll deal with food first because food is the most internally politically sensitive. Variation in food prices have historically had enormous impact on the political stability of China. Let's go back some decades to the events "that never happened" in Tiananmen Square in 1989. We find that those events were driven by a very rapid food price acceleration which in turn generated political instability. What we've got in China at the moment is the beginning of a possible circumstance like that forming from dramatic pork price rises.

The Chinese swine herd which is enormously large, many millions of animals, has been affected by African swine fever. This has meant that there has had to be an enormous amount of the Chinese swine herd destroyed. Thus, the domestic production of pork has fallen. This causes problems with prices and consumer price inflation.

Pork prices domestically in China are up by 75%. This has introduced an acceleration in food prices of 45%. The result of this acceleration is to bring overall inflation to 3%. This is towards the upper end of the inflation range this century. Moreover, core inflation is only 1.5%, which goes to show there's not an industrial problem.

Pork prices rocketing up 75% is a real problem with the potential to increase political instability. What the Chinese have to do is to launch a program to dramatically accelerate the repopulation of the swine herd. They need to find an awful lot of grain to do that. It just so happens that the number one grain exporter of soybeans and feed grains in the world is the US.

As a result, stage one of the potential agreement between China and Trump includes the importation of US$40-50 billion of agricultural products (mostly grains) to China. Historically the largest ever year of China buying American agricultural products was 2013 in which they bought US$29 billion. They are proposing to buy almost twice as much as the previous total record high. This move is absolutely necessary for China to rebuild their swine herd, to get pork prices down and not have that risk of political instability.


Importing Capital

The second thing that China has proposed to do, is to open up the capital market to US financial companies. The reason they're forced to do that can be seen in the outlook for both the Chinese budget balance and the Chinese current account balance within the IMF outlook database. What it shows is a change in the structure of Chinese growth.

I've said previously that China has moved from being a primarily industrial country to primarily a service economy. The problem with that is that as services rise and manufacturing falls as proportion of Chinese GDP, it is still manufacturing which generates most of the export income.

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This article was first published by Morgans.


The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual’s relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so. Those acting upon such information without advice do so entirely at their own risk.

This report was prepared as private communication to clients of Morgans and is not intended for public circulation, publication or for use by any third party. The contents of this report may not be reproduced in whole or in part without the prior written consent of Morgans. While this report is based on information from sources which Morgans believes are reliable, its accuracy and completeness cannot be guaranteed. Any opinions expressed reflect Morgans judgement at this date and are subject to change. Morgans is under no obligation to provide revised assessments in the event of changed circumstances. This report does not constitute an offer or invitation to purchase any securities and should not be relied upon in connection with any contract or commitment whatsoever.

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About the Author

Michael Knox is Chief Economist and Director of Strategy at Morgans.

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