China’s Achilles’ Squeal

The importance of the pig in the Chinese diet is reflected strongly in language. In days past, and still today, to some extent, any family home of the slightest substance would quarter at least one animal. The pig was once such an integral part of normal family life that writing the Chinese character for roof written above the one for pig, creates the word meaning home or family.” – www.eatingchina.com/articles/pork.htm

I’ve long had a side hobby of studying of China, its people, and the Communist Party of China (CCP). They are three distinct things, of course, but the interplay between them is fascinating and widely misunderstood in the West. I’m no Peter Zeihan, to be sure, but having traveled to China twice yearly for the better part of a decade, I’ve had almost 600 hours to kill while sharing the cargo bay with all manner of livestock. I spent much of that time learning everything I could about the Middle Kingdom.

A few months ago, I befriended a true expert in the agricultural commodity space. For business reasons, he is understandably reluctant to allow me to use his real name, so let’s call him Mr. Ag. As a man who literally grew up on a farm and has worked in the industry his entire career, Mr. Ag knows the agricultural market inside out. I have a fair bit of experience in the sector as well, being a chicken and whatnot, so naturally the two of us hit it off. We’ve both come to believe big things are afoot in the Chinese agricultural market and have been developing these views together for several weeks. What follows is the first product of our collaboration.

Let’s begin with the simple observation that the CCP is a paranoid organization, and for good reason. By definition, a government born out of a protracted and violent revolution knows a thing or two about how one’s grip on power can be precarious. In the West, many have an image of the CCP as all-powerful and ruthlessly efficient, but like all totalitarian states, China under the CCP is very much a mixed bag. Under Xi Jinping in particular, the CCP has taken an aggressive stance toward enemies of all varieties, whether they be domestic or international, real or imagined. One enemy all totalitarians must keep in check is food inflation. If the people can’t afford to eat, or they can’t find the food they want to eat, they revolt. The path to many a guillotine has been paved by empty market stalls.

What does Xi see when he looks over his shoulder? The answer might surprise you, but we submit he sees pigs, and he is hellbent on making sure enough big piggies go to market.

The role of the pig in Chinese culture cannot be overstated. Pigs are prolific eaters of just about anything, including human excrement, and thus serve as both as an incredibly rich source of high-protein meat and as one of the keys to the efficient operation of the rural Chinese homestead. A home with a pig wastes very little, whereas a home without a pig has very little. Therein lies the problem for Xi – compared to the Western economies, the Chinese pork industry is distributed, unsophisticated, inefficient, and susceptible to all manner of disasters, while simultaneously being absolutely critical to domestic peace. It is also incredibly difficult to modernize, making it a key threat to Xi’s power. The Chinese people don’t trust the government with something as important as their pigs. It’s an unspoken, nuanced dance. The people dare not express their distrust out loud, and Xi dare not call their bluff, at least not directly. Not yet.

But he’s been working on it.

Xi effectively took control of the CCP in 2012 and was elected President of the People's Republic of China on March 14, 2013. A few short months later in May of 2013, Shuanghui Group, a publicly traded Chinese meat and food processing company, announced its intent to acquire Smithfield Foods, the largest pork producer in the US. With a price tag of $7.1B (including debt), the deal was China’s largest acquisition of a US company to date by a factor of roughly two. Appearing on PBS NewsHour in 2014, US Senator Debbie Stabenow had this to say about the transaction (quote found via Fox Business):

Food security is national security. And I can’t imagine that the American people will feel comfortable if they wake up someday and find that half of our food processors are owned by China. And I think there are some very, very tough questions that need to be answered.

We view that as a classic China-is-strong-and-a-threat take. In reality, it almost certainly signals a desire on Xi’s part to shore up a critical weakness. The Chinese didn’t buy Smithfield to mess with our food supply – they did so to learn how to better run a key part of theirs.  Perhaps because of the sensitivities expressed by the good senator, Shuanghui Group ultimately rebranded itself as WH Group in early 2014, presumably because it sounds a little less, um, Chinese?

Next, Xi turned his sights to the grain market, generally, and soybeans, in particular. What do soybeans have to do with the price of pigs in China? If Xi is successful, everything. A professional and sophisticated pork industry, like those found in the West, begins with a brutally efficient pig farming operation. In such operations, pigs become fat hogs by gorging on soybean meal, a key product of soybean farming. While humans certainly consume a fair number of products derived from soybeans, animal feed is the key driver of the soybean industry. Once farmed, a soybean is typically processed by removing the husks, squeezing or extracting out soybean oil, and drying the remaining solid, which, because of its high protein content, is excellent for animal feed.

In rural China, small pig farmers might incorporate soybean meal into the diets of their pigs, but only as a supplement to table scraps and natural forage, and only if it makes economic sense. In professional pig farming operations, formulated feed rations hit the feed bunks daily with all the discipline of a modern, just-in-time, Six-Sigma-optimized factory. Xi would like more of the latter and less of the former. So, in early 2016, he directed ChemChina to acquire Syngenta.

Mind you, it took until June of 2017 for the deal to close, but close it did. Why was Syngenta such an attractive target? Seeds. Genetically modified seeds. Genetically modified seeds for soybean and corn. Genetically modified seeds for soybean and corn that allow for the prolific use of herbicides, fungicides, and insecticides, all of which Syngenta had on offer, thus increasing yields. Syngenta was a market leader in this biotechnology, making it an irresistible target for Xi (not to mention, handy access to regional demand flows for top-shelf crop protection technology). It was also available to be purchased, being based in Switzerland, with other market leaders like Monsanto, DuPont, Dow, and Bayer out of reach to the Chinese (at least at that time). Certainly, many aspects of Chinese agriculture could benefit from bringing Syngenta into the fold, but both Mr. Ag and I independently and immediately thought of one word when we heard the news of the deal: pigs.

Although China has grown its soybean production by nearly 50% since the Syngenta acquisition, it is still a minor player in the space. WorldAgricultureProduction.com estimates 2020 global soybean production at about 360 million tons, with Brazil holding 37% share, the US with 31%, and China with only slightly more than 5%. Once again, the 2017 acquisition of Syngenta seems more about shoring up a weakness than projecting power. China is still a major importer of soybeans and susceptible to the whims of others. This is, quite logically, unacceptable to Xi.

This weakness was further highlighted in 2018-2019. China was dealing with a widespread outbreak of the African swine fever amongst its domestic pig population while simultaneously fighting a trade war with President Trump. Mr. Ag believes, and I agree, that Xi was hoping to leverage the swine fever outbreak to nudge the population into understanding that a nationalized and professionalized pork industry was in the people’s interest. The despair of local farmers was allowed wide berth on Chinese social media, which is never an accident. Xi was, however, hindered in this effort by Trump’s trade war.

One casualty of the trade war was the export of soybeans from the US to China. As the chart below shows, China was largely able to make up for lost US imports by ramping up its relationship with Brazil. But the situation was unsustainable – something had to give. US farmers were annoyed at losing a key customer, and Xi was walking the knife’s edge domestically with his pig farmer objectives. Cooler heads prevailed, a deal was signed in January of 2020, and exports of soybeans from the US to China began to recover.

What is the current state of the Chinese pig and grain markets? In January of 2021, China launched a new live hog futures contract on the Dalian Commodity Exchange, signaling Xi’s continuing efforts to professionalize and, more importantly, regulate the industry. Pig prices have fallen steadily (see: JCI data charted below), pork supplies are abundant, domestic grain prices are being held higher than imports, and import volumes are robust.

All this is occurring within the backdrop of new reports of African swine fever outbreaks. In other words, Xi has recreated the perfect storm for his ambitions, this time without a pesky trade war. If we are right, the combination of high domestic grain prices and ample pork supply will crush margins for the small pig farmers, while state-operated large pig farms will effectively be subsidized by their access to lower-cost import feeds. Xi is taking another swing at his objective. We don’t expect him to miss.

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