Chinese Salt Bubble

The biggest single riskdeveloping in the global economy is presently coming from commodity speculationagainst pumped up Chinese demand expectations. Everything is already well priced and fresh supply is also in thepipeline everywhere.

This item reminds us just how franticit can all become as money washes over a targeted commodity and disruptscurrent supply and demand arrangements. In the short tem every commodity is in tight supply all the time if youthrow enough money at it.  Past that the warehousesget cleaned out and the speculators end up living with their inventory.

A general slowdown in China willcrush the commodity market and that day of reckoning is a current and present riskeven with the pundits calling for 2014 for such a slow down.  I suspect that the chickens will come home toroost during the next year or even possibly late this year.

In the meantime, enjoy thislittle bit of painful human madness.

Chinese Salt Bubble

By Adam Wolf

Roubini Global Economics

China can blow bubbles faster and bigger than just about any othercountry, but the Extraordinary Salt Mania of March 2011 takes the cake forspeed, size and bizarreness. The brief, dazed run on salt by investorsfollowing the March 11 tsunami demonstratesChina’s susceptibility to speculative bubbles and thepotential to pass on the effects to international markets (discussed further inour China Monthly).

Shortly after radiation was reported to be leaking from Japan’s FukushimaDaiichi nuclear power plant in mid-March, rumors began to spread thatChina’s seasalt could be contaminated by radiation and that iodized salt couldprevent radiation sickness. The apparent demand shock from the rumoredsalt cure and a perceived supply shock from the polluted seawatercaused prices to spike upward of 85% in a matter of days. State media reportedthat a Mr. Guo bought 6.5 tons of salt in Wuhanon March 17, only to see prices collapse three days later after repeated warningsfrom government officials that there was no salt shortage and that consumingiodized salt could not assuage radiation sickness, of which there was nothreat.

In a matter of days, there was a displacement, an apparent expansion ofcredit in the underground market, euphoric buying on expectations ofever-higher prices and finally revulsion once reality sank back in. The meteorshower of shooting salt prices over China is not an isolated example ofspeculation gone awry: The current stockpiling of copper in China’s ports isinflating the global price, which could collapse if regulators put restrictionson the use of the metal as collateral for bank loans. Likewise, Hong Kong’sproperty bubble is partly a spillover effect from the bubble in some of China’s urban high-end markets. Infact, investors are vulnerable to several factors within the Chinese systemthat could affect global asset prices.

First, decades of financial repression have resulted in the broad moneysupply (M2) expanding to 182% of GDP, providing a massive pool of potentialliquidity for speculation, while negative real interest rates on deposits encouragesavers to seek alternatives. There are sufficient monetary assets to fund abubble of stupendous magnitude; no excessive loosening is required. From theend of Q3 2006 to its peak in October 2007, the Shanghai Composite Index increased 230%. Inthe preceding six quarters, M2 growth outpaced nominal GDP growth byless than a percentage point. It was the velocity of money thatspiked, not the quantity. Velocity is more difficult for the People’s Bankof China tocontrol, especially with banks’ required reserve ratios already at record highs, andcurrent conditions seem ripe for a bubble.

Second, the Communist Party of China’s dominance over the press,even independent sources, results in low trust of official information,counteracting their ability to dispel unfounded speculative manias. At the sametime, heavy reliance on social networks, guanxi, results in an abnormalamount of inside information sharing, and thus speculative opportunities.Positive feedback loops proliferate as investors pile into the sameopportunities and bid prices up.

Third, the government’s interference in price setting distorts markets,creating potentially huge divergences from equilibrium. From vegetables toapartments, the government’s efforts to control prices only shifts theadjustment burden to the supply side as markets seek equilibrium. This alsocreates a whack-a-mole game between speculators and the government as liquidityshifts from one asset class to another.

Fourth, “new era” thinking is epidemic in China, and this euphoriaoften spills over into asset price valuations as speculators discounthistorical benchmarks.

Many of these factors can be seen in the Extraordinary Salt Mania ofMarch 2011. A speculator living in a 20-square-meter apartment was able to layout US$4,100 for 260 bags of salt that filled half of his apartment. Rumorsspread quickly through social networks of rising salt prices, while repeatedwarnings about the safety of China’ssalt supply and the dangers of excessive salt consumption went unheeded. TheNational Development and Reform Commission instructed its local price controlauthorities to curb salt hoarding and disrupt the market. The only missingfactor was “new era” thinking, since this short-lived mania was motivated bypanic buying, not delusions of China’sfuture grandeur.

The Chinese system is a game with its own controls that can sendshockwaves through global systems as local prices diverge from global assetmarkets and arbitragers elsewhere narrow the gap. Investors should be carefulto distinguish speculative demandfrom the real thing and avoid feedinginto the next big bubble.