Download Demand from China: Fact or Fiction?

GROWMARK Research
August 2, 2013
Demand from China: Fact or Fiction?
Why China is not the real driver of commodity prices
Executive Summary
It is commonly assumed that China’s rapid economic growth has resulted in its having an increased demand for
and consumption of world commodities, and that this increased consumption by China has driven up global
commodity prices. This report shows that the inverse is true. China’s rapid growth comes from its rapidly
increasing production of goods, with the result that China now produces and supplies more commodities than
most other countries. It consumes mostly its own supply of commodities, not the remaining world supply. It is, in
fact, a net contributor to world commodity supply, not a net taker. As a result, it has thus contributed to lower,
not higher, world commodity prices.
As a minority purchaser of commodities from markets outside its own country, China has a minimal impact on
world prices. Total purchases of commodities by all other market participants in non-Chinese markets is greater
than China’s and thus has a greater effect on prices than does China’s purchases in those markets. It is important
to understand that China trades its own commodities locally in Chinese renminbi; yet the markets and prices
commonly perceived to be affected by China are U.S. dollar markets outside of China, where prices are not
directly affected by Chinese renminbi markets.
Presented here are analyses demonstrating China’s lack of influence on commodity prices. We show that: 1)
other countries have a stronger relationship between their commodity imports and world commodity prices
than China has; 2) although prices of commodities traded in dollars have risen, U.S. exports of commodities have
not generally increased; 3) there is, for most commodities, no relationship between exports of U.S. commodities
to China and their respective prices; where loose relationships do exist, price movements are still more closely
tied to other market participants than to China; and 4) many commodities that China does not buy have
experienced the same volatility as commodities it does buy, indicating that other factors besides Chinese
purchases are driving commodity prices.
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Page 1
The “demand from China” theory fails to explain how all commodities collapsed together during the 2008
financial crisis, while Chinese purchases did not, and, why most commodity prices tend to move in sync, even
though they have different fundamentals. We explain these phenomena by pointing to a different force, new to
the commodity markets, that affects commodity purchases on a much larger scale than does China: the horde of
Wall Street banks, broker/dealers, securities firms, hedge funds, and exchange-traded funds investing in
commodity futures. Wall Street is now responsible for the majority of all spending, purchases, and trades in the
commodity futures markets, which, in turn, bid up cash prices through arbitrage. It is not physical “demand from
China,” but instead monetary demand from Wall Street that drives up prices.
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Page 2
Introduction
In today’s commodity markets, Chinese economic growth and its corresponding “demand” are seen as dominant
forces behind commodity price movements. The theory is that rapid economic growth in China over the last
decade or so resulted in its increased demand of raw materials and other commodities, which pushed up
commodity prices. In this way, China is seen as the primary force behind rising commodity prices in the U.S. and
elsewhere. This report will analyze, in detail, the theory of Chinese economic growth and its demand for
commodities as the cause of rising commodity prices, and will show that China is not in fact primarily responsible
for rising commodity prices. Since the “demand from China” fallacy encompasses multiple smaller fallacies, these
will be addressed as well.
1. Background and Fundamentals
Because this report explains that the misunderstanding of China’s effect on commodity prices stems from a misinterpretation of the economic data associated with this topic, and, because many commodity analysts are not
economists, it is important to first review fundamental economic concepts. More specifically, it is important to
understand the misconceptions in how the commodity “industry” views supply and demand. This review will
help to clarify actual economic cause and effect as related to Chinese commodity purchases.
Given the widespread and entrenched nature of the industry’s misreading of the dynamics of Chinese growth, this
analysis begins with a comprehensive explanation of crucial terms and concepts.
The Concept of “Demand”
While the notion of demand from China is often discussed, consideration is rarely given to what demand actually
means, or should mean. Real demand is a function of what is produced. China and any other country, as well as
any individual worker or company, can demand something—purchase something—only with what it has to
exchange in return. What it exchanges must be something it has already produced: products are ultimately paid
for with products. The baker exchanges bread he baked for shoes the shoemaker made. The shoes pay for the
bread, and the bread pays for the shoes. The more China produces, the more it can exchange for other products or
services that other countries have produced. The more it produces, the greater is its demand. Thus, supply
creates demand.
Notice that what is exchanged is spent, whether in the form of physical products or in the form of money, i.e., a
medium of exchange representing physical products. “Demand” is, therefore, always expressed by actual
spending, not by the mere want or desire for something.
Demand is the desire plus the ability to purchase. Someone might have a “demand” for a good or service, but
unless he can hand over money—or goods or services—his demand is meaningless. Therefore, theoretical
demand, or mere longing, is infinite. True demand is defined only by spending.
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Page 3
Demand and Prices
Similarly, it is important to understand that this monetary demand (spending), not physical demand, i.e., merely
taking possession of the product, is what sets the price of a product. In today’s world, tangible goods are not
traded directly for other goods; instead, currencies, or money, are used to represent the purchasing power of the
goods being exchanged. Thus, the expenditure of money is the specific type of demand which sets the price for a
product, as goods are priced in money, not in physical units such as bread or shoes.
Prices are defined as the ratio of money for goods: a certain amount of money trades for a certain amount of
goods. Thus, the price formula is:
For example, in 2008, $49.1 billion was spent to purchase 12.1 billion bushels of corn in the U.S., resulting in an
average 2008 corn price of $4.06 ($49.1 billion/12.1 billion = $4.06). But in 2011, $76.9 billion was spent to
purchase 12.4 bushels, resulting in an average 2011 price of $6.22. Since the supply between the two years
remained about the same, the only factor driving prices higher was the 57% increase in spending for the same
amount of supply.
When both supply and demand are expressed in physical units, there is nothing in the equation that yields a
monetary figure. Merely counting how many units were purchased says nothing about the price paid, nor does it
explain the price paid. When both supply and demand are in physical units, the numerator and denominator—or
demand and supply—are two sides of the same coin.
To bring this full circle, and to emphasize the notion that monetary expenditures, not physical possession,
constitute demand, let us return briefly to the baker and shoemaker example. When the baker trades one loaf of
bread for one pair of shoes, the price of the shoes in this transaction is one loaf of bread. What’s the supply of
shoes? It’s one pair of shoes. What’s the demand for shoes? Most commodity experts would argue that it’s one
pair of shoes—as opposed to the actual demand of one loaf of bread.
Now consider the next transaction where three loaves of bread are exchanged for one pair of shoes. What’s the
price of a pair of shoes in this transaction? It’s three loaves of bread. What’s the supply? It’s still one pair of shoes.
And what is the demand? If the answer is still one pair of shoes, we have a situation where supply and demand
are unchanged but the price is now three times higher. In reality, then, the demand is three loaves of bread, as
more bread was offered for the shoes, making the price of shoes rise by a factor of three. No matter how common
it is to call demand the taking and use of the physical product, the taking of the physical product is meaningless
without knowing how much money is paid for the physical product.
The Fallacy of Growth Causing Higher Prices
We have established that increased production and supply leads to increased real demand. But it cannot be
emphasized strongly enough that increased production and supply, and thus increased real demand, on an
economy-wide basis, does not lead to higher prices.
© 2013 GROWMARK, Inc. All rights to the material or compilations contained herein are hereby expressly reserved.
No part of this publication may be reproduced in any form or format without written permission granted by GROWMARK, Inc.
Any distribution or reproduction of this material is prohibited and may be in violation of copyright laws, conventions or
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Page 4
Unfortunately, over time, we have been (mis)led to believe that economic growth and rising prices go hand in
hand. People typically assume that an increase in economic growth is synonymous with an increase in monetary
incomes that pushes prices higher (so-called aggregate demand increases). This is a key misconception, because
increased production, i.e., increased economic growth: 1) leads to falling, not rising prices, and 2) does not raise
wages.
When a country is truly growing, it is so-called aggregate supply—not aggregate demand—which is expanding,
due to increased productivity. In other words, growth must be understood as the production of more things, not
the spending of more money: companies and other producers produce goods, not money. With an increasing
supply of goods, all else being equal, prices will fall, not rise, as shown in Figure 1. (Importantly, new and
additional money in an economy is neither needed nor helpful in producing more goods.)
Figure 1: Consumer price changes in an economy with a static amount of money.
Scenario 1: The Quantity of Money Remains Unchanged
Assumptions:
Quantity of money = $1,000,000 in both years
Production of all goods increases by 10% per year
Demand for each product relative to other products stays the same every year
1,000,000
Year 1
Goods and jobs In
the Economy
Jobs
Units
Produced
(Units of
Jobs
Existing)
Year 2
Total
Share of
Unit Price
Amount
Total
(Salary for
Spent for the
Spending
Jobs)
Good/Job
50
50%
$
500,000
Shirts
400
1%
$
5,000
$
Microwave ovens
100
1%
$
10,000
$
4
3%
$
25,000
$
70
8%
$
75,000
$
Sandwiches
4,000
1%
$
10,000
Shares of stock
2,000
5%
$
50,000
Tons of grain
50
15%
$
150,000
Barrels of oil
450
3%
$
25,000
3
15%
$
150,000
7,127
100%
$ 1,000,000
Electric generators
Steel sheet
Houses
Totals/Averages
Increase in Quantity of Goods Produced: 10%
Rate of price Inflation:
-9%
Rate of salary inflation:
0%
Rate of increase in living standards:
9%
$ 10,000
Units
Produced
(Units of
Jobs
Existing)
Total
Share of
Unit Price
Amount
Total
(Salary for
Spent for the
Spending
Jobs)
Good/Job
50
50%
$
500,000
440
1%
$
5,000
$
11
100
110
1%
$
10,000
$
91
6,250
4.40
3%
$
25,000
$ 5,682
1,071
77
8%
$
75,000
$
$
3
4,400
1%
$
10,000
$
2
$
25
2,200
5%
$
50,000
$
23
$
3,000
55
15%
$
150,000
$
56
495
3%
$
25,000
$ 50,000
3.3
15%
$
150,000
100%
$ 1,000,000
$
13
6,724
7,835
$ 10,000
974
$ 2,727
$
51
$ 45,455
$
"CPI"
6,113
"CPI"
In Figure 1, the supply of goods increases each year, but the supply of money does not. Therefore, since the same
quantity of money is spent on more goods than before, the price of each good falls (very last column). The supply
of jobs also does not increase, because the population remains the same. To the extent that the population did
© 2013 GROWMARK, Inc. All rights to the material or compilations contained herein are hereby expressly reserved.
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Page 5
increase, the supply of goods would be even greater and prices would then be even lower, since with more people
producing there would be more goods created.1
Absent more people producing, the supply of goods increases by way of each worker being able to
produce more goods. Each worker’s productivity increases by way of having more capital at his or her disposal—
more tools, factories, machines, computers, etc.—which aids to production are part of what workers are
producing when they produce. Whether there is price inflation or not, real wages rise only by way of having
prices fall relative to wages, not by having money wages go higher. Expanded supply and lower real prices are
how standards of living increase. This is what constitutes true economic growth.
Despite increased productivity and production that should drive prices lower, we observe prices rising
each year. That’s because the government separately but simultaneously prints additional money and adds it to
the economy, thereby causing prices to rise (i.e., it creates inflation).2 In any economy, the sole force behind rising
prices experienced during periods of economic growth is necessarily increased money creation by the central
bank.3 And —by keying digits onto a computer screen—the central bank can create money faster than companies
can create real goods. By inducing inflation, central banks try to offset growth-induced price decreases and
“stabilize” market prices. However, through this increased supply of money, they don’t just “stabilize” prices; they
push them higher. This money printing causes the familiar outward shift in aggregate demand (purchasing power
expands) that keeps prices constant despite a supply increase.
In Figure 2, we have the same production situation as in Figure 1, the only difference being that the
central bank expands the quantity of money by 20% between year 1 and year 2. The result is that, although
supply has increased by 10%, it has been outpaced by the 20% growth in money supply, resulting in nominal
prices rising 9%. This is the scenario occurring in growing economies in today’s world, wherein nominal prices
rise, but real prices fall, in effect raising real wages.
1
And each person’s real wage would remain the same.
Before it began doing this in 1913, prices fell most years and decades.
3
It should be noted that so-called full employment or a supposed “overheated economy” does not and cannot increase prices.
2
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Page 6
Figure 2: Consumer price changes in an economy with an increasing amount of money.
Scenario 2: The Quantity of Money Expands by 20%
Assumptions:
Quantity of money = $1,000,000 in Yr. 1, but increases to $1,200,000 in Yr. 2
Production of all goods increases by 10% per year
Demand for each product relative to other products stays the same every year
1,000,000
Year 1
Goods and jobs In
the Economy
Units
Produced
(Units of
Jobs
Existing)
Year 2
Total
Share of
Unit Price
Amount
Total
(Salary for
Spent for the
Spending
Jobs)
Good/Job
50
50%
$
500,000
Shirts
400
1%
$
5,000
$
Microwave ovens
100
1%
$
10,000
4
3%
$
25,000
Jobs
Electric generators
$ 10,000
Units
Produced
(Units of
Jobs
Existing)
Total
Share of
Unit Price
Amount
Total
(Salary for
Spent for the
Spending
Jobs)
Good/Job
50
50%
$
600,000
13
440
1%
$
6,000
$ 12,000
$
14
$
100
110
1%
$
12,000
$
109
$
6,250
4
3%
$
30,000
$ 6,818
70
8%
$
75,000
$
1,071
77
8%
$
90,000
$ 1,169
Sandwiches
4,000
1%
$
10,000
$
3
4,400
1%
$
12,000
$
3
Shares of stock
$
27
Steel sheet
2,000
5%
$
50,000
$
25
2,200
5%
$
60,000
Tons of grain
50
15%
$
150,000
$
3,000
55
15%
$
180,000
Barrels of oil
450
3%
$
25,000
$
56
495
3%
$
30,000
3
15%
$
150,000
3
15%
$
180,000
7,127
100%
$ 1,000,000
7,835
100%
$ 1,200,000
Houses
Totals/Averages
Increase in Quantity of Goods Produced:
Rate of price Inflation:
Rate of salary inflation:
Rate of increase in living standards:
10%
9%
20%
9%
$ 50,000
$
6,724
"CPI"
$ 3,273
$
61
$ 54,545
$
7,335
"CPI"
As production expands Central banks and the banking system must create more money in order to prop up
prices. Just because economic growth and prices are increasing together does not mean that one is causing the
other. Rather, growth prompts money printing, which in turn prompts rising prices; growth does not directly
cause inflation without a monetary response from a central bank—no matter the level of employment.
It should now be clear that increased production, supply, and real demand (i.e., true economic growth)—on an
economy-wide basis—do not cause prices to rise. Increased demand for some goods relative to other goods will
increase prices of those particular goods, but overall increased real demand will not increase overall prices in the
economy —it will lower them.
Economic Growth and Commodity Prices
Now that fundamental economic concepts have been reviewed, it should be helpful to analyze from scratch how
the “demand drives prices” thinking comes about, incorporating a real-world oil usage example.
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Page 7
The common view of increasing demand and higher prices for commodities is that as an economy grows, it needs
more commodity-oriented materials for the purposes of building, fueling, and eating. Thus, as an economy grows,
people and businesses “demand” more commodities. “Demand” is viewed as merely taking possession of the
commodity, and is seen as driving up prices regardless of how much money is spent to purchase the
commodity—it is implicitly assumed that money is spent, but the magnitude of the monetary spending is still
seen as irrelevant.
However, a growing economy is defined not by an increased demand to consume, but by increased supply, which
would lower prices, not raise them. If prices go higher it is not because of an increased physical “demand,” but
because of an increased monetary demand.
The economy does not produce more goods each year because consumers “demand” more goods. We do not
produce 20 times more now than 100 years ago because people decided they wanted to consumer 20 times more
than they used to. They have always wanted to consume more, but at any level of economic development, there is
a finite production capacity in the form of capital, tools, machines, technology, etc. Producers are always trying to
produce more—assuming it’s profitable to do so—because the more they sell, the more they can make. There will
generally always be a real demand for additional products, because other people in the economy are also
producing more products with which they will pay for the additional products.
Figure 3: Evolution of world crude oil supply and demand.
100.00
95.00
90.00
85.00
80.00
75.00
70.00
65.00
60.00
2002
2003
2004
2005
2006
2007
Total World Supply
2008
2009
2010
2011
2012
Total World Demand
Source: Informa Economics, authors’ calculations
And lower selling prices brought about by increased supply do not usually mean less profitability, as producers
can sell more units at a lower per-unit price, keeping total revenues the same. We need to look only at the
computer industry over the last 40 years to see that lower prices do not constitute less real demand and
therefore less production. The same can be said of the entire 19th century, where production increased
dramatically as prices fell year after year.
Therefore, generally speaking, there is not really an increased physical demand economy-wide through time;
there’s just an increased purchase and usage of commodities because more have been created and are available
to be used. There is always a theoretical want and need to consume additional goods and resources; the desire for
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Page 8
more of most things is insatiable. But just using the increased available supply does not constitute an increased
demand. Thus, there is no specific, finite annual physical demand for most things, as is commonly assumed.
There can be increased production and supply of a good or commodity relative to another, due to an increased
amount of spending that raises its price and profitability of production, and thus incentivizes more capital to be
allocated to it from other locations in the economy, so that its output is increased relative to what it would
otherwise be. But again, the increased relative demand is in the form of more money spent for the existing supply,
not in the form of merely using the existing supply.
Consider the global supply and demand numbers for crude oil in Figure 3. Most oil experts, familiar with these
numbers and observing that supply and physical demand rise together in almost perfect unison4, will conclude
that the associated prices are rising solely due to the increase on the demand side. Granted, they do not state this
explicitly; but they do state it implicitly when they say that increased demand is driving prices higher. For
example, it has often been said that rising oil prices in the mid-2000s were due to increased demand resulting
from the strong economy, and that subsequent lower oil prices during the so called Great Recession were a result
of less demand, given the sluggish economy. But as the chart shows, the supposed increased physical demand was
really just the increased supply of oil being purchased and used—because it could be. (Similarly, analysts will
speak of Middle East tensions threatening oil supplies, while the data show that they don’t usually affect the
supply. Instead, more money is spent based on the perception that supply could be disrupted.)
Figure 4 shows the rate of change of crude oil supply, demand, monetary spending (monetary demand), and
price, and shows that the physical demand for crude oil fell by a mere 1.3 percent during the Great Recession—
there was in fact no strong demand collapse as commonly claimed. Instead, the demand that changed was the
monetary demand—the red line—that was spent for an almost unchanged physical supply.
An absolute economic law to remember is that if the supply of a commodity is static or increasing, its price can go
higher only if more money is being spent on that commodity. Observing consumption and ignoring supply and
spending provides no meaningful insights.
4
Most commodities’ supply and physical demand numbers do not move in exact parallel due to partial production that is held off the
market and carried over to the next year. But even in these cases the supply and demand are very tight, and essentially revolve
around one another through time. A forthcoming paper will address the (minor) effect of carryover on prices.
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Page 9
Figure 4: World crude oil supply, demand, monetary demand and price percentage change, yearover-year
50%
40%
30%
20%
10%
0%
-10%
-20%
-30%
-40%
2002
Supply
2003
2004
Price
2005
2006
2007
Demand ($)
2008
2009
2010
2011
2012
Industry's "Demand" (physical units)
Source: Informa Economics, authors’ calculations
To say that purchasing a commodity that is created—crude oil, in this case—represents any kind of true demand
is essentially the same as saying that crude oil came to being in the 1850s to begin with because there was a
“demand” for crude oil even though people had never known about it before (the same can be said of microwave
ovens or hula hoops). Similarly, according to this thinking, the price of crude oil should have risen throughout the
rest of the 19th century and during the 20th century as the use and physical “demand” increased exponentially
worldwide, especially in the U.S. and northern Europe. Instead, the price of oil fell through most of this time
period. How did physical demand rise for decades while the price fell for decades? Because the pace of supply
increases outstripped the pace of spending for crude oil. Prices only began to rise in the early 1970s as the U.S.
went off the gold standard, and dollars spilled out of reserves and onto world markets in dramatic fashion, raising
the prices of all commodities simultaneously.
2. The China Effect
With a clear understanding of demand and prices, this analysis moves to the claim that China’s economic growth
is driving prices higher. The following sections will assess this claim, and offer detailed explanations of how China
cannot be responsible for most of the price changes in dollar-based commodity markets.
China and the U.S. Economy
It should now be clear that China’s growing economy does not drive Chinese consumer prices higher; money
printing and a monetary expansion of the renminbi by the Chinese central bank drives these prices higher.
Can China affect American consumer prices? No, it cannot in general, because the U.S. has its own separate
currency, the U.S. dollar. It is the quantity of dollars—along with moderate changes in the supply of American
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Page 10
goods—that affects aggregate prices in the U.S. Only by exporting more goods to the U.S., thereby increasing the
supply of goods and lowering consumer prices can Chinese economic growth affect US prices.
How, then, could China, by buying so many of our commodities, be pushing up U.S. commodity prices, specifically,
with its economic growth?
The Currency Effect
To answer this question, it is important to recognize that, in assessing U.S. commodity prices, we are actually
concerned only with dollar-based markets. The commodity prices commonly seen by the media and academia as
affected by Chinese growth are those in western markets, and purchased in U.S. dollars.
Prices in dollars are determined only by the supply and demand for commodities traded in dollar-settled markets
(as opposed to just dollar-denominated markets.) Commodities traded on exchanges outside the U.S. and Europe
are generally traded in local currency, even though commodities are referenced world-wide in dollars. Prices
move at different rates in different currencies (Figure 5), even though arbitrage and the law of one price ensures
that a commodity tends toward the same real value across currencies, after accounting for transportation costs,
etc. For each currency in which a commodity is traded, the commodity’s price in that currency is determined by
1) the amount of money spent in the respective currency to buy the commodity and 2) the actual supply of
commodities being purchased in that currency, as discussed in Section 1.
Figure 5: Commodities in different currencies: Rice (left) and corn (right) as priced in selected
domestic markets in their respective domestic currencies, indexed.
Rice
Corn
5
3.25
4.5
2.75
3.5
4
3
2.25
2.5
1.75
2
1.5
1.25
1
0.75
2005
2006
2007
2008
2009
2010
2011
2012
2013
0.5
2000
2002
2004
2006
2008
2010
2012
China: yuan per MT
India: rupee per 100 kg
Mozambique: meticals per kg
Philippines: pesos per kg
Ecuador: U.S. dollar per kg
United States: dollars per MT
Niger: CFA franc per kg
United States: dollars per MT
Source: Food and Agriculture Organization of the United Nations
Source: Food and Agriculture Organization of the United Nations
Commodities traded in one currency do not have any direct impact on prices in another currency. Prices and
supply of commodities in non-dollar-based markets do affect dollar prices indirectly by affecting the sellers’
supply to dollar-based markets, as well as the amount that buyers spend in dollar-based markets; but, they do not
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Page 11
directly affect the price in dollar-based markets. Global commodity competition, arbitrage, information,
perception, supply, desire, concern, etc., are transmitted to dollar-based markets only by spending more or fewer
dollars in dollar-based markets or offering more or less supply to those markets.
The U.S. dollar corn price, for example, is determined by the corn traded in the U.S. in U.S. dollars, since that is the
only location where corn is paid for in dollars.5 Corn traded in Argentina, which is quoted in dollars but settled in
Argentine pesos, does not directly contribute to determining U.S. dollar corn prices; only indirectly by impinging
on the amount of U.S. dollars spent in dollar markets, and the amount of corn supplied to dollar markets. For this
reason, we focus only on dollar-based markets.
A Possible but Unrealistic Argument
The idea that China could directly dominate dollar-based commodity prices is plausible in theory. Either by
purchasing dollars with Chinese renminbi or using some of its $3 trillion in dollar reserves, China could re-direct
dollar purchasing power away from other American consumer goods, causing those prices to fall, and towards
commodities, causing those prices to rise. But this is unlikely for many reasons, including that during the recent
commodity boom, other goods prices in the U.S. went higher, not lower. Non-commodity goods have gone higher
because of an increased quantity of money circulating in the American economy. The increased money supply has
had at least some influence on commodity prices as well, meaning that domestic price inflation likely plays at
least some role. This will be examined later.
The overwhelming reason, though, that Chinese U.S. dollar spending has not been a primary driver of U.S.
commodity prices is that China does not purchase enough dollar-based commodities to have a dominant effect on
dollar prices. It is a minority purchaser with a minority effect. For example, in 2008, the year of peak commodity
prices, China purchased only 10.5% of U.S. agricultural exports, less than Canada, Mexico, and Japan each
purchased. The rest of this section will show in detail how the money redirection and “demand from China”
theories are incorrect.
The China Argument’s Data
Not only does the China demand argument sound plausible, but some data would seem to support it. Consider the
chart in Figure 6 from an IMF research paper, showing that China imports and uses significant amounts of the
world’s commodities.6
The chart is indeed valid7, but it is important to interpret it correctly. As a first step, consider that the chart
reveals that the most influence China could possibly have over these commodities is 50% (the red bars). In order
to purchase the commodities, China must spend money for them. This increased spending is how prices rise
5
This is the case to our knowledge. To the extent that corn is traded in any other country in dollars, the dollars spent and the supply
purchased in that market would also directly affect the U.S. dollar price due to “clean” arbitrage opportunities, and would be equivalent to
the spending and supply existing in the U.S. itself.
6
See Shaun K Roache, “China’s Impact on World Commodity Prices,” http://www.imf.org/external/pubs/ft/wp/2012/wp12115.pdf.
7
Though the scale should go to 100%, not 80%.
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Page 12
(absent supply reductions). In order to increase the commodities’ prices, China must bid up the prices by
increasing the amount of money it spends. According to the chart, China’s spending is no more than 50% of the
total spending for these commodities. Therefore, the combined effect of all market participants besides China has
at least as much influence on these commodity prices as China does.
Figure 6: China’s share of selected global commodity markets, in percentage, as presented in an IMF
research paper (Iron Ore added by this paper’s current authors).
80%
70%
Imports Share of Global Trade (2009)
Consumption Share of Global Production (2010)
60%
50%
40%
30%
20%
10%
0%
Source: Shaun K. Roache, IMF/United States Department of Agriculture, United Nations COMTRADE database, World Metal Bulletin
Statistics, and authors’ calculations.
The Corrected Understanding
But in reality, China has significantly less than 50% influence over most U.S. dollar commodity prices, as these
statistics don’t tell the story they appear to. The statistics imply that China is going out into the world market and
taking large percentages of the production of other countries, and—implicitly—bidding up prices in the process.
But instead, China is taking mostly small percentages of other countries’ production. This is because China’s
import share of global trade (the first statistic in Figure 6) is itself only a small portion of the global production
and supply, and its consumption share of global production (the second statistic) refers mainly to what China is
itself producing, not what it’s taking from other countries.
A closer look, using cotton as an example, will help to better explain. Starting with the consumption statistic, it
states that China consumes 48.5% of each year’s global cotton production. But, according to USDA data, China
itself has produced the majority—54-72% depending on what’s being counted as “consumption”—of its
consumption (for many commodities, such as Iron Ore, China produces almost the entire amount it consumes). It
is wholly invalid, then, to count China’s own production as contributing to driving up world prices. The amount
that China produces contributes to the global supply of commodities, not the global demand for them—its
contribution to global supply leads to lower prices, not higher ones. While the commodities world constantly
speaks of consumption driving prices, it fails to consider that there cannot be consumption without
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Page 13
corresponding production. Thus, people speak of increased consumption and demand without considering that
there must necessarily have been at least as large an increase in the supply of commodities to enable this
consumption. No bigger mistake could be made than thinking that China’s own production raises world
commodity prices. 8 This point alone should be enough to disprove the China demand argument.
China actually produces 30.5 million bales of cotton of the 56 million it consumes (thus lowering prices more
than raising them), and imports only 12 million bales.9 Chinese imports of 12 million bales means that China
takes only 13.9%—not 48.5%—of other countries’ production in the global market, which totals a mere 10.3% of
world production (remember that the statistic reports the “consumption share of global market,” not the
“consumption share taken from non-Chinese markets”). In 2010, the year referenced in the IMF chart and the year
we’ve been working with, China took 30% of all cotton traded and sold on U.S. markets, specifically.
While it is true that as of 2012 China took 59% of all U.S. cotton, that was the first year Chinese purchases
constituted a majority, and it is the only commodity of which China has bought a majority share. 10 It can thus be
said, only as of 2012 and only for cotton, that China has a majority control over the U.S. dollar price. However, it
still cannot be said, even for cotton, that Chinese purchases were responsible for driving prices higher over the
last decade—only that China would have made a minority contribution to the rising price. But in fact, cotton
prices happen to be at the same level they have been since the mid-1970s precisely because the total spending to
buy cotton has not increased: as China buys more, other market participants buy less.
It is important to highlight China’s large contribution to the supply, as opposed to the demand, of world
commodities. China is the largest producer of a majority of the world’s mineral-oriented commodities, and one of
the top producers of agricultural commodities. Consider, for example, the commodity production statistics shown
in the series of charts in Figure 7.
8
To use our oil analogy once again, to say that China’s consumption of its own production and supply raises global prices is similar
to saying that it is OPEC’s production and supply, instead of its restraint of production and supply—the thing that’s usually cited as
raising oil prices—which is raising oil prices. It’s like saying that the massive production and supply created by the U.S. consumer
electronics industry over the last several decades should have led to rising electronics prices. Of course, electronics prices have
actually fallen, because the increase in supply outpaced the spending to buy the supply. But in contrast to electronics, the supply of
commodities grows slowly, and the spending to buy commodities outpaces the supply.
9
The missing 14M bales are a result of China having consumed more than the total of its production and imports. The 14M bales are
equal to the difference between the term “consumption” and total production + imports, as China’s consumption, according to the
IMF calculation, is 56M bales (world production of 116M bales x 48.5%), but the sum of China’s own production plus its imports is
42.5M bales, according to the USDA Foreign Agricultural Service. If we assume that Chinese imports were the whole of the difference
between consumption and domestic production, the respective numbers in the current paragraph would be: imports = 25.5 bales,
which means China takes 30%--not 48.5%--of other countries’ production, accounting for 22% of world production.
10
This is the case to our knowledge. We are quick to concede that, since we do not have access to comparable data for all
commodities; we do not know for certain that there are not others that China does not buy a majority share of on U.S. markets.
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Page 14
Figure 7: China’s share of production of selected global commodities
Iron Ore Production
Rank by Country
China
Australia
Brazil
India
Russian Fed
Ukraine
South Africa
Iran
Canada
United States
Kazakhstan
Sweden
Venezuela
Cotton Production
(Thousand metric tons)
92,000
66,476
55,313
33,000
31,700
26,696
22,290
17,700
14,900
Rank by Country
880,000
394,000
300,000
245,000
Source: United States Geological Survey (USGS) Minerals Resources Program
(1000 400 lb. Bales)
China
India
United States
Pakistan
Brazil
Uzbekistan
Australia
Turkey
Turkmenistan
Greece
Burkina Faso
Mexico
Mali
Argentina
9,300
6,300
4,500
4,200
2,600
1,600
1,150
1,100
1,060
1,000
800
(1000 MT)
Rank by Country
101,000
143,000
EU-27
China
India
United States
Russian Fed
Canada
Pakistan
Australia
Ukraine
Turkey
Iran
Argentina
Kazakhstan
Egypt
Uzbekistan
Brazil
37,717
27,200
23,300
22,000
15,761
15,500
14,000
11,000
9,841
8,500
6,700
4,300
132,251
120,600
Aluminum, Primary Production
(1000 MT)
72,500
54,670
26,500
21,500
21,000
20,922
13,060
13,000
9,410
8,900
7,994
61,755
94,800
Source: United States Department of Agriculture
Corn Production
Rank by Country
35,000
Wheat Production
Source: United States Department of Agriculture
United States
China
Brazil
EU-27
Argentina
Mexico
India
Ukraine
Canada
South Africa
Nigeria
Indonesia
Russian Fed
25,500
Source: United States Department of Agriculture
Milled Rice Production
(1000 MT)
Rank by Country
China
India
Indonesia
36,900
Bangladesh
34,000
Vietnam
27,710
Thailand
20,500
Phillippines
10,990
Myanmar
10,750
Brazil
8,160
Japan
7,756
Pakistan
6,800
United States
6,356
Egypt
4,700
17,010
208,000
273,832
Source: United States Department of Agriculture
(1000 MT)
Rank by Country
China
Russian Fed
Canada
Australia
United States
Brazil
India
Norway
UAE
Bahrain
South Africa
Iceland
3,815
3,030
1,943
1,727
1,536
1,400
1,130
1,010
870
809
785
Source: United States Geological Survey (USGS) Minerals Resources Program
Copper Mine Production
Rank by Country
(Metric tons)
Chile
3,356,600
Peru
1,107,789
China
940,000
Australia
833,000
United States
801,000
Russian Fed
750,000
Indonesia
632,600
Canada
606,999
Poland
429,000
Kazakhstan
420,000
Zambia
383,000
Iran
241,000
206,000
Brazil
Source: United States Geological Survey (USGS) Minerals Resources Program
12,900
Hydraulic Cement Production
Rank by Country
China
India
United States
Japan
South Korea
Russian Fed.
Brazil
Turkey
Mexico
Iran
Italy
(Metric tons)
1,388,380
177,000
87,610
62,810
53,900
53,600
51,865
51,432
47,609
44,400
43,030
Source: United States Geological Survey (USGS) Minerals Resources Program
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Page 15
Now consider the other statistic in the IMF chart, the one showing China’s import share of global trade being
30%. The 2009 global cotton trade of 33 billion bales is itself only a minority share (36%) of the global
production of 102 billion bales, meaning that China imports a minority share of a minority share. As seen above,
China imports only 13.9%, or 12 million bales from other countries (15.5%/11 million bales in 2009)—that is the
extent of its impact on global markets outside of China in terms of increased prices. If China’s demand for world
cotton supply were really that great, the global share of trade would be a much greater portion of global
production, because China would outbid more local buyers in various countries, and cause cotton sellers to
export more cotton instead of selling it domestically, as they currently do. In other words, China’s demand for the
larger share of global cotton production is much weaker than the demand exercised by all other cotton buyers in
these non-Chinese markets.
To better understand the relative spending volumes of dollar-based markets, some actual examples would be
helpful. First, consider the soybean market, where it is a well-known “fact” that China drives U.S. soybean prices,
since it purchases around 60% of U.S. exports. The chart in Figure 8, showing a sharply rising volume of soybean
exports to China, is the statistic most often presented as supporting evidence that China is driving up U.S. soybean
prices. Indeed, it looks impressive when presented by itself. However, the fact is that the 60% of our exports that
China takes still amounts to only about a third of our total production, and is therefore a small portion of what
actually trades on our markets and of what establishes a dollar price for soybeans.
Figure 8: China’s imports of U.S. soybeans (metric tons).
30,000
25,000
20,000
15,000
10,000
5,000
0
1992
1996
2000
2004
2008
2012
Source: USDA Foreign Agricultural Service
Figure 9 shows the same data as in Figure 8, except in terms of the actual amount of money spent to buy the
soybeans in Figure 8, compared with the total spending of all other buyers in the U.S. soybean market. Though
China’s spending for soybean exports from the U.S. is significant, its magnitude is still much smaller than the
spending of other soybean buyers in the U.S. soybean market. Figure 9 also presents the same relative spending
volumes for cotton and rice.
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Page 16
Figure 9: China’s spending for soybeans, rice, and cotton, compared to the spending of other market
participants.
Spending for Soybeans
$Million
Spending By China
Spending By All Other Market Participants
30,000
25,000
20,000
15,000
10,000
5,000
-
Source: Source: USDA Foreign Agricultural Service
Spending for Rice
$Million
Spending By China
Spending By All Other Market Participants
3,500
3,000
2,500
2,000
1,500
1,000
500
-
Source: USDA Foreign Agricultural Service
Spending for Cotton
$Million
Spending By China
Spending By All Other Market Participants
7,000
6,000
5,000
4,000
3,000
2,000
1,000
-
Source: USDA Foreign Agricultural Service
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Page 17
Minority vs. Majority
A minority share of trades in a market generally cannot drive up prices more than in proportion to its share of
total spending. Imagine, for example, a market where, in the current year, the price of commodity x is $1. In this
market, there is $100 million in spending that purchases 100 million units of commodity x ($100M/100M units =
$1). Imagine further that China purchases 30% of the commodity, paying $30 million for its share (30% x 100M
units = 30M units; 30M units times $1 = $30M). Also imagine that in the prior year, China had purchased none of
the commodity, and that its $30 million was not yet part of the spending in the market. Last year’s spending
would therefore have been $70 million for 100 million units resulting in a price of 70 cents per unit ($70M/100M
units = .70).
China’s additional $30 million, the total it spends for commodity x, raised the price by only 43 percent, i.e., the
difference between $100 million in spending and $70 million in spending, divided by the supply of 100 units. For
commodity prices to rise 200 percent, 300 percent, and 400 percent, as has been the case in the dollar-based
commodity markets in recent years, there has to have been significant spending over and above the dollar
amount that China spent on its 0-35% share of various commodity markets. Instead of an additional 30% of
spending added to the commodity markets, as per our example, there has to have instead been an additional 100
percent to 300 percent of spending added—sums of money greater than what China alone has spent.
For example, between 2006 and 2007, soybean prices rose from $6 per bushel to $10 per bushel. An additional
$9 billion in spending was required to increase prices by the additional $4. However, China spent only an
additional $1 billion that year. Therefore, China was not the main source of soybean price inflation.
Even if an increase in minority spending by the minority spender caused the majority spenders to spend more, it
couldn’t easily be considerably more. This is primarily because if the majority spenders could easily pay more,
they already would have. Prices in any market are what they are based on the quantity of money the buyers are
able to spend in a market. It’s hard to spend much more if one doesn’t have much more to spend (unless one buys
less of another product to fund the increased spending).
As an economic rule, as prices rise, the quantity demanded falls, given that the amount of money people have and
are thus willing to spend remains fairly constant. However, as will be shown below, when a new group of
spenders entered the commodity markets with significant money to spend, the traditional spenders, who had
now become minority spenders, did in fact increase their total spending slightly, since they came upon some new
and additional money via greater revenues and profits.
Imports from China
Another example that has been presented as evidence that China drives commodity prices is a graphical
representation of the co-movements between China’s imports of commodities and raw commodity prices, where
both Chinese imports and commodity prices are in U.S. dollars. Figure 10 shows the co-movement on a rate-ofchange basis of Chinese imports of agricultural raw materials (a World Bank definition of agricultural materials)
and the World Bank’s raw material price index. Clearly, starting around the mid-1990s, Chinese agricultural
imports and agricultural prices began moving together.
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Page 18
The relationship becomes much more pronounced (after the late 1990s) when we look at the co-movement
between Chinese fuel imports and the corresponding World Bank energy index in the second chart. The third
chart showing Chinese ores and metals imports and metals prices is a little less correlated, but still shows an
increasing—if loose—relationship through time. Before the late 1990s, the two series appeared to move in
opposite directions.
Figure 10: Panels of three commodity group price indexes paired up against Chinese imports of the
same commodity group.
1
World Bank Raw Material Index
Chinese Ag Raw Material Imports
0.5
0
-0.5
1985
1990
1995
2000
2005
2010
Source: World Bank, authors’ calculations
World Bank Energy Index
Chinese Fuel Imports
1.40
0.40
-0.60
1985
1990
1995
2000
2005
2010
Source: World Bank, authors’ calculations
World Bank Metals Index
Chinese Ores and Metals Imports
1
0.5
0
-0.5
1986
1991
1996
2001
2006
2011
Source: World Bank, authors’ calculations
But instead of proving that Chinese imports significantly affect US Dollar agricultural prices, these charts, when
compared to charts showing co-movements of other countries’ commodity imports with commodity prices,
support the argument that Chinese imports have a minority impact on commodity prices. The series of grids of
charts in Figure 11 shows the relationship between the imports of the top six importers, by country, as of 2011,
of the commodities discussed above, with the same corresponding commodity indexes.
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Page 19
Many countries have a more correlated relationship between their commodity imports and commodity prices
than does China. Japanese imports in particular appear the most correlated with commodity prices. Therefore, if
we were to say that the relationship between commodity imports and commodity prices reveals who is driving
prices, we would have to conclude that Japan drives them much more than China. Incidentally, the IMF paper
referenced above concluded that China’s effect on commodity prices was not as large as that of the United States’.
The proximate cause of the strong relationships shown in these charts likely comes from the fact that the
importing countries are, at least in part, importing U.S.-originated commodities in U.S. dollars, with the index
prices also in U.S. dollars. Indeed, Japan imported more agricultural products from the U.S. than any other country
between 1985 and 2010, the time period of the data presented, giving it the most correlation. (The authors do not
have access to the equivalent data for the two other commodity groups.) Therefore, the more dollar-priced
commodities a country imports, the more its dollar value of imports will fluctuate, or correlate, with U.S. dollarpriced commodities. This shows the impact the currency/money has on economic data from both a causality and
a measurement perspective.
Figure 11: The dollar value of imports (blue line) of the top commodity importers in different commodity
groups versus the price index (red line) for the respective category (% change from prior year).
Agricultural Raw Commodity Imports versus Raw Commodity Price Index
Germany
0.4
USA
0.4
0.2
0.2
0
0
-0.2
-0.2
-0.4
-0.4
1985
1990
1995
2000
2005
2010
Japan
0.4
1985
1990
2000
2005
2010
Italy
0.4
0.2
1995
0.2
0
0
-0.2
-0.2
-0.4
-0.4
1985
1990
1995
2000
2005
2010
France
0.4
1985
1990
2000
2005
2010
2005
2010
Netherlands
0.4
0.2
1995
0.2
0
0
-0.2
-0.2
-0.4
-0.4
1985
1990
1995
2000
2005
2010
1985
1990
1995
2000
Source for all charts: World Bank, authors’ calculations
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Page 20
Fuel Imports versus Energy Price Index
1.00
Japan
1.00
USA
0.50
0.50
0.00
0.00
-0.50
-0.50
1986
1990
1994
1.00
1998
2002
2006
2010
1986
1990
1.00
India
0.50
0.50
0.00
0.00
-0.50
1994
1998
2002
2006
2010
South Korea
-0.50
1986
1990
1994
1.00
1998
2002
2006
2010
1986
1990
1994
1.00
Germany
0.50
0.50
0.00
0.00
1998
2002
2006
2010
Italy
-0.50
-0.50
1986
1990
1994
1998
2002
2006
1986
2010
1990
1994
1998
2002
2006
2010
Source for all charts: World Bank, authors’ calculations
Ores and Metals Imports versus Metals Price Index
1.00
1.00
Japan
0.50
0.50
0.00
0.00
-0.50
Germany
-0.50
1985
1989
1993
1.00
1997
2001
2005
2009
1985
1989
1.00
USA
0.50
0.50
0.00
0.00
-0.50
1993
1997
2001
2005
1997
2001
2005
1997
2001
2009
South Korea
-0.50
1985
1989
1993
1.00
1997
2001
2005
2009
1985
1989
1.00
India
0.50
0.50
0.00
0.00
-0.50
1993
2009
Italy
-0.50
1985
1988
1991
1994
1997
2000
2003
2006
2009
1985
1989
1993
2005
2009
Source for all charts: World Bank, authors’ calculations
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Page 21
Exports to China
Another indication that China does not drive up dollar-based commodity prices is the general absence of
correlation between exports to China from the U.S. (the largest market for commodities traded in dollars) and
rising commodities prices. If China’s additional purchases of dollar-priced commodities were the driver of prices,
then one would expect to see not only increased exports to China as commodity prices rose, but also a clear
correlation matching exports to price increases.
The data, however, show that there is little to no relationship in most cases between prices and U.S. exports.
Remember, the timing would have to be exact between the two series, as prices are only bid higher by the
increase in spending. Figure 12 shows the relationship between total exports of selected agricultural
commodities and their prices. The focus is solely on agricultural products, as the equivalent data for other
commodity groups are not easily obtainable. Exports in this chart are in physical volumes, not in dollars, as was
the case in the last set of charts. This is because the argument of the commodity experts/industry is that physical
demand is driving up commodity prices. Note that it is this difference between the measurement of trade in
dollars versus in units that yields correlations in our previous exercise but does not yield them in this one, due to
the monetary effect.
Except for cotton and soybeans, the data do not show exports increasing through time in a sustained manner in
Figure 12, contrary to what the China demand theory holds. There are only some partial, temporary comovements between the selected commodity exports and their price.
In the case of cotton, exports jump long before price, and then fall as price continues upward—thus, there is a
temporary co-movement before another inverse movement.
Corn has no relationship at all with Chinese demand, and it should not, because China generally does not
purchase corn. When it does, these purchases amount at most to 2.4% of U.S. corn exports and .004% of total
production. The story is comparable for rice, oats, wheat, and the coarse grains index overall, since China does
not buy those items either.
Soybean prices, after moving in opposite direction to exports until 2002, then began moving in the same general
direction. But note that even here, soybean prices fell by around 50% in 2008, while Chinese exports continued to
rise.11 Additionally, soybean prices actually rose sooner and at a much faster rate than did Chinese purchases
during the 2005-2007 period of strong price gains.
The agricultural products index relationship with price is very similar to that of soybeans, as it is dominated
volume-wise by soybeans. For the most part, agricultural exports and prices are seen moving in opposite
directions, except for a brief period in the second half of the chart, where the upward trend would appear to be
correlated briefly between 2008 and 2010, before falling apart in 2011. The brief correlation is very likely
coincidental, especially since agricultural commodity prices fell about 50% during 2008 while exports kept rising.
11
The full extent of the 2008 collapse is not revealed in the chart, as it does not show intra-year movements.
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Page 22
Figure 12: U.S. exports of selected commodities exported to China (left scale) compared to the
prices of those commodities (right scale). (Exports in MT, crop prices in futures prices.)
Agricultural Exports
Cotton
2,000
Corn
$200
Cotton Exports
Cotton Price
1,500
$150
1,000
$100
500
$50
0
6,000
1994
1998
2002
2006
3,000
$400
2,000
$200
1,000
0
2010
$0
1990
1994
1998
Soybeans
30,000
20,000
$1,600
$1,200
15,000
$800
10,000
$400
5,000
0
1994
1998
2002
2006
5
2010
$20
Rice Exports
Rice Price
4
$15
3
$10
2
$5
1
2010
$0
1990
1994
Wheat
5,000
2006
0
$0
1990
2002
Rice
Soybean Exports
Soybeans Price
25,000
$600
4,000
$0
1990
$800
Corn Exports
Corn Price
5,000
1998
2002
2006
2010
Oats
$1,000
0.05
$800
0.04
3,000
$600
0.03
$300
2,000
$400
0.02
$200
1,000
$200
0.01
$100
$0
0.00
Wheat Exports
Wheat Price
4,000
0
1990
1994
1998
2002
2006
2010
30,000
20,000
10,000
0
Agricultural Exports
Agricultural Products Price
$400
$0
1990
1994
Agricultural Products
40,000
$500
Oats Exports
Oats Price
1998
2002
2006
2010
Coarse Grains
$300
6,000
$250
5,000
$200
4,000
$150
3,000
$150
$100
2,000
$100
$50
1,000
$50
$0
1990 1994 1998 2002 2006 2010
Source for all charts: USDA Foreign Agricultural Service
Coarse Grains Exports
Coarse Grains Price
0
$300
$250
$200
$0
1990
1994
1998
2002
2006
2010
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Page 23
Other commodities, such as poultry meat, saw their prices rise as Chinese imports from the U.S. increased
through 2008, then continued rising as Chinese imports fell by more than half. Further, China has purchased only
7% of U.S. poultry meat production over the last 10 years. Therefore, we can consider the rise of poultry prices
and Chinese imports through 2008 as coincidental. Similarly, China has continued to import increasing amounts
of many other commodities, including metals and energy, since 2008, while most commodity prices are
considerably lower, and/or have fallen since then. This also goes against the China demand theory.
Perhaps the most persuasive evidence that China does not drive commodity prices is that the prices of
commodities that China buys as well as the prices of commodities that China does not buy (or buys only
minimally) have risen equally. Figure 13, covering the years 2002 through 2012 (i.e., the period of the
commodity boom for most commodities), shows that a handful of commodities of which China buys less than 2%
(less even than .02% in most cases) have seen price gains comparable to those it buys in large quantities. Thus
the chart suggests, if not proves, that something other than purchases by China moves commodity prices.
Figure 13: Indexed prices of selected commodities that China does not purchase compared with the
average prices of all commodities (grey/black bars).
7
6
5
2002 Average Price
2007-2012 High
4
3
2
1
0
Source: USDA Foreign Agricultural Service
Exports in General
Still more export data puts into question the China demand theory. If China was driving up U.S. prices with its
increased purchases, agricultural exports would have increased in the last decade. This has not happened.
The median ratio of (physical) exports as a percent of total use/total distribution across all agricultural
commodities between 2002 and 2012 fell by 1%, meaning that exports as a percent of total use/total demand in
2012 were no higher than in 2002. The median growth rate of exports between 2002 and 2012 fell by 3%. The
raw total volume of agricultural exports, depending on what’s counted as “agricultural,” rose between 0 and 10%.
Even if the “right” number is the full 10%, that certainly would not explain a rise in prices of 100-400%; and
again, the 10% export growth is in proportion with the supply and usage growth. How were exports of the other
commodities basically stagnant as China demand grew? Because most of them, even those of soybeans, saw other
importers buy less as China bought more.
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Page 24
While it is theoretically possible for China to have overtaken other importers’ shares by bidding the price
higher—and it has to a smaller degree—the previous calculations and analyses show that China could not be
responsible for the full extent of the price moves that have occurred.
3. The Non-China Effect
Problems with the “China Demand” Argument
Proponents of the “China demand” argument ignore the following problems with their position: 1) that virtually
all commodity prices plummeted in 2008, and to a lesser degree in 2011, while Chinese purchases held steady,
and 2) that commodity prices tend to move together as a group, suggesting that they are all responding to a
specific force other than China’s purchases.
Almost all commodities, from sugar, orange juice, pork bellies, milk, and grains to silver, platinum, zinc, steel, coal,
propane, and crude oil, have experienced both large price rises and price collapses, nearly simultaneously. This is
not to say that there have been one-for-one moves in prices by the month between these commodities, but to say
that, while most commodities were largely flat during the 1980s and 1990s, almost all have seen substantial price
increases of 100-400% starting between 2002 and 2006, and most saw dramatic price collapses of 20-60%
during late 2008.
Not only do commodities move in sync, but in recent years they have also moved in the same direction as asset
classes such as stocks and bonds. Between July 2008 and September 2011, for example, commodities, as
measured by the Rogers International Commodity Index, were 93% correlated with the S&P 500. Such a
relationship is not a historical occurrence, as commodities traditionally have an inverse correlation with equities.
Since each commodity has individual fundamentals unrelated to other commodities, price movements should not
naturally be correlated.
The high correlation of commodities with each other and with other financial assets—along with the related fact
that commodities fall, along with financial assets, by as much as 50% during financial crises, even as China
continues purchasing them—shows that China cannot possibly have a dominant effect on commodity prices.
There are other forces at work.
The Other Big Spender
Why, then, does this co-movement take place? And what other force could there be that would have such a strong
effect on commodity prices? The answer is that the influential price-driving spender is Wall Street investors, i.e.,
banks, investment firms, hedge firms, broker/dealers and the like, who, cumulatively, far outspend China. It is
these financial investors, or speculators, who sent prices lower in 2008, and who cause all commodities to move
more or less in sync with each other, and loosely in line with other asset classes. These correlations occur
because when Wall Street buys, it tends to buy commodities across the board—for the sake of diversification; and
when it sells, it sells rather evenly across all its commodity holdings. It also buys and sells commodities at the
same time it buys or sells stocks and bonds (until 2012, at least); thus, the correlation there.
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Page 25
Though Wall Street money has always been in the commodity futures markets to a smaller degree,
unprecedented quantities of money flowed in between 2002 and 2006 (1998 for the energy markets). Over this
period, the total volume of spending in the futures markets increased by a factor of four to six times its prior level
(Figure 14). By all accounts, the primary drivers of the investor money inflows were 1) the flight from the
collapsing stock markets in the early 2000s, and 2) the desperate need for diversification by Wall Street
investors. Commodities were the “last man standing” for diversification opportunities, as most asset classes,
including global stocks and bonds, had become correlated with one another.
It is important to note that the futures market leads the cash markets—especially during the large run-ups seen
during the last 10 years. This is confirmed by many academic studies, as well as simple empirical evidence such
as that presented for corn in Figure 15. Futures prices are then transmitted to cash prices via arbitrage.
Figure 14: Total futures market spending since 1986 on the commodities listed in the chart.
$600
CrudeOil
NaturalGas
Soybeans
$500
Corn
Wheat
$400
OrangeJuice
Billions
Cotton
Coffee
$300
Sugar
LiveCattle
$200
LeanHogs
SoybeanOil
Copper
$100
Platinum
Silver
$0
1986 1989 1993 1994 1996 1998 1999 2001 2003 2005 2006 2008 2010 2012
Gold
Source: CFTC, authors’ calculations
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Page 26
Figure 15: Futures versus cash prices of corn, showing that futures leads cash.
$9.00
Futures
Cash
$8.00
$7.00
$6.00
$5.00
$4.00
$3.00
$2.00
$1.00
2005
2006
2007
2008
2009
2010
2011
2012
2013
Source: World Bank, USDA Agricultural Marketing Service
Another view of the large inflows of money into the commodity markets is as an “overflow” of the large amounts
of money that have poured into financial assets in general since the early 1980s. Due to changes at that time in
the financial system and the creation of the Shadow Banking System, the off-balance sheet bank and investment
entities that fund and pyramid loans into financial investments, newly created bank credit now flows
disproportionately into financial assets relative to the real economy, thus causing booming stock, bond, housing,
and commodity prices (i.e., high asset price inflation), and at the same time tame consumer prices (i.e., low
consumer price inflation). That’s what booming commodity prices—and other asset prices—are: inflation.
Wall Street investors/speculators have access to hundreds of billions of dollars of funding at low interest rates
from Wall Street banks, which include European banks holding and lending as many U.S. dollars as domestic
banks. Additionally, Wall Street firms often leverage their assets at up to 32 times their capital. By engaging in
large-scale bank borrowing through financial tools such as commercial paper, asset backed securities and
repurchase agreements, they injected over $10 trillion of credit, or 70% of GDP, into the financial markets during
the 2000s. The growth rate of credit responsible for fueling asset prices was much more rapid than the growth
rate of the money supply, which is the primary fuel for consumer prices (Figure 16). Inevitably, commodities
were one of the asset classes into which some of that sheer mass of financial markets credit flowed.
The increase in money and credit also explains why many analysts find correlations—as high as .80—between
commodity prices and the movement of the U.S. dollar12 (but hardly any with Chinese economic growth). It is the
increase in the supply of dollars in excess of the increase in the supply of other currencies which pushes the value
of the dollar lower against other currencies.
12
See for example: http://www.forbes.com/sites/greatspeculations/2013/07/23/commodities-take-cues-from-dollar-not-china/
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Page 27
Figure 16: Money versus credit: the growth the traditional money supply versus that of financial market
credit instruments.
7.5
M2 Money Stock
Repurchase Agreements, Overnight & Continuing
6.5
Commercial Paper Outstanding
5.5
4.5
3.5
2.5
1.5
0.5
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
Source: Federal Reserve Bank of St. Louis; Federal Reserve Bank of NY
Not only has new Wall Street money flowed in, but at times, it has quickly flowed out. Investors/speculators, who
were the primary funders of the housing boom as well as holders of the majority of asset-backed securities and
other types of home mortgages, were the initiating cause and driving force of the 2008 financial crisis and its
corresponding stock, bond, housing, and commodity market crash, as well as of the 2011 summer sell-off. In
2008, many speculative investors were forced to quickly sell out of their commodity market positions due to
negative events—wholly unrelated to commodity production or uses—that were unfolding in the credit markets
(e.g., the Lehman Brothers collapse and a lack of short-term funding in the money market).13 This flight from
commodity futures caused commodity prices to collapse, as there were suddenly many more financial sellers
than commercial buyers. In 2011, fears of a Greek sovereign debt default and the associated funding pressures in
the financial markets caused commodity markets to plummet when financial investors deleveraged and cashed
out of their investments all at once.
Although these financial investors/speculators have nothing to do with the various industries that produce or use
commodities, they nonetheless are buyers of commodities and they compete against traditional buyers (i.e., users
of commodities) with their investment dollars. Thus far, they have outbid a majority of traditional commodities
buyers.
In fact, in recent years financial/speculator purchasing has represented the vast majority of spending in the
futures market. For example, since 2006, over 65% of transactions in the corn futures market have consisted of
speculator funds, and 40% of those transactions come from index investors specifically. Similarly, 82% of
spending in the wheat market is done by Wall Street, as is 87% in the oil futures market. Additionally, 80% of
13
For a broader explanation of how problems in the financial system caused a sell-off in the commodity markets, please see “What
Happened in 2008?” (by Kel Kelly) in the September 13th issue of Farm Week Magazine:
http://farmweeknow.com/blogs.aspx/happened-2008-provides-lesson-3607
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Page 28
trades on the futures market consist of day trading, not long-term purchases. Clearly, Wall Street dominates the
commodity markets.
The charts in Figure 17 give a visual depiction of the vast volumes of Wall Street spending by showing the money
flow of both commercial-oriented traders and of Wall Street.14 The first chart uses the older CFTC Commitment of
Traders (COT) data that classifies futures traders by category. The value of this chart, since it goes back further
than the new COT data,15 is in showing how Wall Street money flowed into the futures market in the 2000s. For
perspective, according to the old COT data, during the 1980s and 1990s commercial money flow was periodically
up to 15 times greater than financial money flow. It averaged 4 times greater in the 1980s, 3 times greater in the
1990s, and 2 times greater in the first half of the 2000s. But in the last half of the 2000s, the ratio of commercial
to financial money flow was 1 to 1, as can be seen in Figure 17.
The other three charts show corn, cotton, and live cattle spending based on the newer COT data that started in
2006. The new classification was intended to further dissect and classify the type of traders, in part because many
traders were being grouped incorrectly. Under the newer, clearer classifications, it is obvious that Wall Street
investors make up the vast majority of the spending on these futures markets—averaging 2-4 times that of
commercial spending—and that their spending patterns are very highly correlated with futures prices (.92 for
corn). (There is now also a strong correlation between commercial spending and corn prices, but that did not
exist prior to 2006, when Wall Street money flowed in.)
Clearly, neither China nor any other commodity merchant entity is responsible for a majority of the spending in
commodities. Financial investment in commodities, not Chinese purchases, is the more powerful force causing
price increases.
14
Money flow is equal to price times open interest, since price times quantity equals total revenues/total spending.
It must be pointed out that our chart goes back to 1999 while the old COT data goes back much further. The reason for not
showing the older data is only because it could easily be misunderstood. As the numbers become smaller as the chart goes back
further, the relative magnitude of the scales change. This makes it appear as though prices rise without much additional spending.
However, this is not the case, as the spending is still in proportion to the price movements (adjusted for supply changes).
15
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Page 29
Figure 17: Futures market spending divided between Wall Street and non-Wall Street players (left-hand
side is price, right-hand side is billions of dollars in spending) 16
Corn (Old Data)
$10
$60
Financial Money Flow
$9
Commercial Money Flow
$8
Corn Price
$50
$40
$7
$6
$30
$5
$20
$4
$10
$3
$2
1999
$0
2001
2003
2005
2007
2009
2011
Corn (New Data)
$10
$9
$8
$7
$6
$5
$4
$3
$2
$1
2006
Financial/Speculator Money Flow
$60
Nonclassified Purchasers
Commercial Money Flow
$50
Corn Price $/Bushel
$40
$30
$20
$10
$0
2007
2008
2009
2010
2011
2012
Live Cattle
$140
Financial/Speculator Money Flow
$130
$20
Nonclassified Purchasers
$120
Commercial Money Flow
$110
Live Cattle Price (cents/CWT)
$15
$100
$90
$10
$80
$70
$5
$60
$50
$0
2006
16
2007
2008
2009
2010
2011
2012
Cotton and live cattle charts contain futures prices, while corn contains cash price. Detailed data was not kept prior to 2006.
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Page 30
Cotton
Financial/Speculator Money Flow
$170
Nonclassified Purchasers
$15
Commercial Money Flow
Cotton Price (cents/lb.)
$120
$10
$70
$5
$20
2006
$0
2007
2008
2009
2010
2011
2012
Source for all charts: U.S. Commodity Futures Trading Commission, authors’ calculations.
Conclusion
China is not responsible for the majority of the price increases experienced by most commodities over the last
decade, as the facts show: there are neither consistent correlations between prices and Chinese imports from
dollar-based markets, nor increases in exports from U.S. markets in general. Indeed, research shows that China
does not purchase enough of our commodities—even of soybeans—to have a significant effect on price.
China, being the largest producer of many, if not most commodities, is increasing the world supply of
commodities—not the world demand for them. The country consumes mostly its own production, not that of
other countries.
Increased production and supply contribute to falling, not rising prices. If supply is increasing, prices can rise
only as a result of increased spending, which is in turn made possible by central banks, separately but
simultaneously, creating new money.
Commodity prices are rising—in sync and across the board, even for commodities China does not purchase—
because a disproportionate amount of newly-created money is flowing into financial assets, which includes
commodities, through Wall Street investors. Wall Street buys most commodity futures contracts, and is
responsible, on average, for more than 70% of the spending on those commodities. It is therefore Wall Street, not
China, that is most responsible for rising commodity prices.
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Page 31
This paper is the second in a series of four:
“4 Reasons Why Ethanol Doesn’t Drive Corn Prices,” January 2013
“Demand from China: Fact or Fiction?” August 2013
“The World is Not Hungry,” Forthcoming
“The Stocks-to-Use Ratio: Is it Meaningful?” Forthcoming
Scott Hornblower is an analyst with GROWMARK, focusing on the financial system and
commodity prices. Contact him: [email protected]
Kel Kelly is in charge of GROWMARK’s Economic and Market Research. Contact him:
[email protected]
About GROWMARK
GROWMARK is a $10 billion regional agricultural cooperative based in Bloomington, Ill. GROWMARK is
owned by local member cooperatives and provides those cooperatives and other customers with fuels,
lubricants, plant nutrients, crop protection products, seed, structures, equipment, and grain marketing
assistance. In addition, GROWMARK provides a host of services from warehousing and logistics to
training and marketing support. The GROWMARK System serves customers in more than 40 states and
Ontario, Canada.
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Page 32