China and the United States has engaged in a massive game of chicken, one that presents a lose-lose scenario for consumers in both countries. Especially US soybeans farmers and Chinese livestock producers (and in turn, the Chinese consumer)
In a trade war, there are no winners, regardless of the rhetoric or tweets that are sent by one party or the other.
This week has been quite wild for soybean traders. Wednesday’s announcement that China would slap 25% tariffs on US soybeans fueled a massive selloff. However, soybean prices bounced back over the final two trading days as cooler heads prevailed.
President Donald Trump’s top economic adviser Larry Kudlow (he’s running out of economic advisers) has said that we aren’t in a trade war yet. Kudlow explained that China’s tariffs on US soybeans and other producers are just in proposal form. The markets took Kudlow at his word and soybean prices were recouped their losses.
Now, geopolitical risk and global trade have been the basis of my career and education for 20 years. I absolutely love talking about these issues, reading about these issues, and debating on the topics. But the thing that too many people don’t understand is that the threat of a major geopolitical threat is always quite low. The noise surrounding the issue makes it seem like there is a 50-50 chance of anything happening, whether it’s a nuclear war or the collapse of NAFTA.
Political noise is the problem.
This week there are two key points that I would like to discuss with you.
• First, I want to discuss the real problem with Chinese-US soybeans trade; and
• Second, I want to show why US soybeans farmers can relax around this issue.
Let’s dig in.
Crowded Trades Don’t Last Forever
If you’re a soybean farmer, you’re exposed to what is known as a “crowded trade.” This isn’t just a Wall Street term. It’s common in almost every area of business.
Do you remember when everyone was getting their real estate license in 2005?
Or why no one would be quiet about Bitcoin last year in 2017?
There were many, many people all buying into the same business in an effort to make money. And in a lot of cases… it was fast money.
House flipping made the real estate industry a fast way to make money.
Bitcoin buying and selling had the same frenzy of the Beanie Baby rage of the 1990s.
But not everything lasts forever. The real estate market imploded in 2008. The Bitcoin bubble burst this year.
A popular trade around the Swiss currency being pegged to the Euro blew up a few years ago, and several hedge funds went under overnight. That same thing happened a few weeks ago with people and financial firms that were betting against volatility in the stock market.
It especially happens in the agricultural sector as well.
Five years ago, how many sorghum farmers did you know? This year, U.S. farmers were planting more and more of the feed grain because of the premium they could obtain from China. “Selling soybeans to China” has been the mother of all crowded farming trades for a decade. When someone says that farmers are in trouble because of the reliance on Chinese buying, one must wonder how and why this occurred in the first place.
Look at this chart.
Does this look like a stable situation for American farmers?
The U.S. ships more than half of its soybeans to China. And while that’s good for business and international cooperation, what exactly is the backup plan if something goes awry?
The U.S. is not diversified in its customer base.
For just a moment, forget trade tariffs.
What would happen if a war broke out in the South China Sea?
What would happen if a massive economic crisis hit China (thus reducing demand for soybean meal)?
Or what if there was another unknown event that no one has even considered (a Black Swan event).
All of these scenarios have real probabilities and even greater ramifications than a temporary trade spat. They would create a real shock in Chinese demand. But tariffs are not going to affect the reality that Chinese demand remains robust. That’s why it’s important to explain why the net effect of these tariffs on US soybeans is basically nothing.
US Soybeans, Take a Deep Breath
Right now, U.S. and Chinese officials are negotiating a deal between the countries. That goes unreported by many because the Chicken Little tale gets more attention.
Neither country wants a trade war. And neither nation can afford one.
For China, the proof of this argument is in the numbers. The country will need to import more than 100 MMT of soybeans this year in order to meet demand from its surging soy oil and feed demand.
Now, we know that there are three major producer-exporters of soybeans: Brazil, the United States, and Argentina. Smaller exporters like Paraguay and the Ukraine combine for just 12% of global exports.
Now, if you’ve covered our in-depth grain markets analysis in GrainCents, you know that Argentina’s crop is in horrible condition due to drought conditions across the country. But even in an average year, Argentina is more of a soybean products exporter than a shipper of raw beans.
While China has threatened tariffs on the U.S., they have turned to Brazil to source their beans. While the country might have a crop around 119 MMT this year, it requires about 46 MMT to 48 MMT to meet domestic needs. About 49 MMT of Brazil’s exports go to China.
Karen Braun at Reuters projected that China will have a soybean deficit of about 31 MMT without US soybeans in the equation. So, where exactly will all of these beans come from? Again, they might be able to pick a few million tonnes from Paraguay, Ukraine and even Canada.
Or China could turn to replacement crops. They could maybe pick up canola, wheat, sorghum, DDGs, or even more barley. But none of these crops have the protein content desired by the feed lots across the country.
But there’s still a big gap, and China will have to take more costly steps to fill their quotas.
To start, it’s possible that China arrives in Brazil and can get that number higher. But they have to do it by bidding higher if they can capture – at most – another 8 MMT to 9 MMT of Brazilian beans.
But guess what has happened as they’ve pushed for more beans just with the threat of a trade war? Premiums in Brazilian ports surged.
The sheer number of soybeans that China will demand is only going to drive up the price in South America. The same goes for prices in all of the other nations that could be potential sources of origin. Meanwhile, given that soybeans are a global commodity with significant demand – other importers will turn to U.S. origin to meet their needs.
The reason why so many people have freaked out about the threat of a soybean tariff from China is because of that chart above. The U.S. has relied on this crowded trade with China for a very long time.
But so long as our export trade groups get to work and start thinking about how Mexico or Japan might be interested in more US soybeans or maybe even trade directly with Argentina or Brazil as they look to increase their own exports to China, we’re going to see our crops find customers.
It’s very easy for the narrative to cause a temporary spike in blood pressure. But I’ve seen this same type of saber-rattling in the past, and it’s important to keep your cool. We’re not going to tell you what you want to hear, and we’re not going to use fear as a tactic to get you to click on our articles. We’ll tell you what you need to hear, even if that message is a simple as “don’t panic and enjoy your weekend.”
We’re here to give our analytics perspective and will happily debate anyone in the public sphere in a respectful manner.
So, let’s take a breather from the trade war rhetoric, okay?