China will gradually let global markets determine prices for grains and other major crops according to a feature in the China Economic Times that got worldwide attention last week when Reuters and other wire services picked up on it. Since 2004, Beijing has set floor prices for rice and wheat and stockpiled corn, soybeans, sugar and cotton at fixed-prices to insure profitable and all-out production by farmers. (These floor prices worked somewhat like loan rates in the U.S., with price support the intended goal.)

But Beijing has determined its current policy of setting guaranteed domestic prices often above world levels, buying up domestic production for “government reserves” and placing strict quotas on cheaper imports is unsustainable. The most dramatic example is in cotton, where China’s offer to farmers is nearly double current futures prices for cotton and that country’s projected ending stocks account for 19 months’ worth of annual consumption and 60% of the world’s total projected ending stocks in USDA’s November WASDE report!

Beijing learns it cannot repeal laws of supply and demand. Note this telling statement from Ms Fang Yen, head of China’s National Development and Reform Commission (NDRC), as quoted in the China Economic Times feature: “Grain prices have come to the stage to be decided by the market.” Then she added, “The existing policy has supported domestic grain prices to rise only, but not to fall, which is against the basic rule of value.”

Beijing also learns “laws of unintended consequences.” By forcing grain and cotton processors to pay much-above global prices for domestically produced commodities, China’s millers, feed and cotton mills could no longer compete with cheaper imports in their own domestic market, raising the need for strict import limits. But this, in turn, raised cries of “protectionism” and threats to slap levies, quotas and tariffs on China’s exports. It led to systematic fraud and corruption. For example, Chinese importers began to lure farmers into selling imported commodities to the government as their own production and then sharing the profit with them.

To reassure its own farmers and consumers, Beijing leaders say they will take a “go slow” approach for staple grains like rice and wheat, however and will “gradually” allow global markets to determine China’s domestic ag prices. They say cotton will be used as a “test” of the new policy next season but that they may “temporarily extend” price controls on politically-sensitive crops like rice and wheat.

They plan to maintain a target price concept, for example, but pay farmers deficiency payments when domestic prices fall short of the target price. No longer will government just build more bins and warehouses and hold the commodities “off the market”, similar to the intent of the U.S. Farmer-Owned Reserve program of the 1980s. Also planned are other types of subsidies and insurance incentives to boost farmer income without distorting market prices.

“Land reform” is another key change coming for China. Ever since the communist revolution, all urban land was owned by the state and all rural land was under “collective” (village) ownership. Individual families were allowed only a small plot (less than 3 acres) as “their own”, raising whatever they wished, but without any rights to sell or develop their plot. Beyond tending their own plot for personal use, Chinese farmers worked essentially like migrant workers on farm “collectives” managed by officials who grew whatever they were told to grow by other officials higher up the chain of command.

That’s about to change, big-time. A reform master plan is about to set up a private rural property market allowing peasants to transform their “collective” rights into a shareholding system. A pilot program will even enable the mortgaging and transferring of privately-owned “homesteads.” Since the 1990s, this approach has flourished in the cities. Government could acquire collective land “for public use” by Vol. 18, No. 48 12/6/13 compensating occupants, then sell to private real estate developers. It’s been a major engine of growth and development in China’s cities and now they plan to use it to develop a private rural farmland market as well. The goal? To gradually transfer private property rights to all 650 million of China’s rural population.

Longer-term, we see reason for optimism in U.S. ag trade potential in four key tactics revealed in China’s master plan for market reform focus specifically on freeing up exports and imports:

1. The existing “free trade zone” (FTZ) in Shanghai will be replicated at other key port cities along China’s coast.

2. The Commerce Ministry will actively increase imports in general, but particularly of “food and energy” due to well-recognized limits on available farmland and energy reserves in China.

3. The Commerce Ministry will also aggressively assist Chinese companies in developing overseas marketing networks and to establish world class quality and “world famous brands” of Chinese products.

4. The Commerce Ministry will aggressively pursue bilateral and multilateral trade agreements with both developed and emerging countries that “recognize and complement each other’s comparative advantages.”

But short-term, the reforms may actually reduce U.S. exports of commodities for which China holds enormous and costly-to-maintain reserves and begins to meter these reserves back into its domestic market at globally-competitive prices. U.S. cotton exports are the most likely casualty.