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The price of tea in China — and what it means for your clients

Big trouble in the big country could whack portfolios closer to home

May 11, 2011 @ 2:09 pm

By John Goff

An interesting — and somewhat worrisome — article from Bloomberg today reported that China's inflation rate held above 5% in April. In fact, the inflation rate in the People's Republic has exceeded Premier Wen Jiabao's 4% target each month this year. Food prices are rising even faster, probably at a double-digit clip. It's hard to tell exactly how much faster, since many observers believe Beijing has for years been less than forthright in its reporting of statistical data such as GDP growth and — yep — the rate of inflation.

This is not good. And if you're asking yourself what the price of tea in China has to do with you or your clients, the answer is simple.

Plenty.

How? Sinologists, as well as others who know how to read from right to left, will tell you that inflation is, has been and always will be the paramount concern of China's paramount leaders. The riots of 2007 and 2008 were a clear indication that the hundreds of millions of peasants in China cannot — and will not — tolerate substantial hikes in the price of staples like garlic, tea and ginger. Those who like ginger tea are doubly sensitive.

Indeed, memories of the damage caused by inflation is burned deep into the collective psyche of the Chinese people and their leaders. The history of the Middle Kingdom is littered with tales of empires toppled by runaway prices and an angry mob. One of the reasons Mao Ze-dong was able to run the Nationalists out of the country was a jaw-dropping rise in the price of goods. During the Chinese civil war of the late 1940s, wholesale prices in Shanghai rose 7.5 million percent over the course of three years. Any faster and the entire country would have started traveling backwards in time.

Then there's Tiananmen Square. Granted, some of the unrest in 1989 was triggered by lack of rights and rampant government corruption. But the main reason people got so worked up was because inflation had soared.

As Harvard history professor -- and noted Braniac -- Niall Ferguson recently told Consuelo Mack on WealthTrack: "The Chinese are very nervous when they see enormous crowds in the streets of major cities, because they remember Tiananmen Square in 1989. And they know that one of the reasons things blew up in 1989 was in fact that inflation got out of control." He added: "They do not want a repeat of that. That is their No. 1 priority. No disorder."

Mr. Ferguson is spot-on, or at least as spot on as anyone can be who's first name resembles an eye chart. Beijing is not about to let inflation — let alone hyperinflation — rile up the populace. This means the People's Bank will continue to limit price hikes, continue to curb the money supply — and continue to crack down on what's seen as speculative lending.

It won't be easy. "Credit growth in China is crazy," Mr. Ferguson said. "It's off the charts."

As anybody who's ever lived there will attest, the People's Republic is filled with people who like to place the occasional bet or two. An effort to tamp down on speculation of any sort — particularly property speculation — will require a giant tightening of the screws by the People's Bank and the twirling of millions of shiny objects by the Ministry of Provinces and Induced States.

Here's the punchline. An iron fist in Beijing — aimed at reining in manufacturing and construction in the PRC — will smack Occidental tourists right in the teeth. Specifically, diminishing demand in China for industrial metals such as silver and copper, as well as energy supplies, will derail the commodities gravy train that U.S. investors have been riding for the past year or so. "They hit the brakes," Mr. Ferguson said, “and that's the point at which the commodities markets starts to slow down."

It's also the point at which you'll probably start hearing from your clients. I'm guessing they won't be using their inside voices, either.

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