Thursday, May 01, 2008

What's Up With Food?

As you probably know, the world's food prices are soaring. So far I've come across two basic explanations which I find reasonable for the hike in food and commodity prices.
  • Increased demand, constrained supply.

    This one is straight from your basic Econ 101 textbook. The increase in demand is attributed to the high growth rates in China and India, the newly richer Indians and Chinese demand more food. The supply hasn't kept up with demand hence the rice in food prices.

    The reasons for the supply constraints are attributed to the use of agricultural land for bio fuels (ethanol in the U.S. for example). This is yet another example of how climate change hysteria and resulting policy is actually doing more harm than the climatic effects of the supposed phenomena (I call it Al-flation).

    Second reason (See Tyler Cowen's excellent piece in the New York Times) there isn't enough international trade in foodstuff and the everywhere in the world there's a plethora of government interventions in the agriculture markets distorting price signals which stops produces from effectively responding to the increased demand.

    Also the resulting panicky situation from high food prices creates even more government intervention like putting in place price controls like in Sri Lanka and banning export of rice in India all of which destroys incentives for increased production.

  • It's created by loose monetary policy.

    This time the culprit is the U.S. Federal Reserve. The explanation is the monetary expansion in the U.S. via lower interest rates is causing higher inflation and a weaker dollar. Most commodities (including agricultural commodities) are priced in dollars, and when the dollar weakens the prices of commodities in terms of dollars go up. This also invites speculation of future declines driving up the prices further. See this chart from WSJ for example,

    The chart shows rapid increase in the price of oil in terms of dollars relative to euros since September 2007, about the time the US Fed started it's loose monetary policy practices. The hike in oil prices in terms of euros is fairly moderate, like the WSJ says, "had the dollar merely retained the same purchasing power as the euro, today's price of oil would be below $70 a barrel"

    Add to this picture that some developing countries (like Sri Lanka and India) partially pegs it's currency to the U.S. dollar basically importing U.S. inflation in addition to creating it's own inflation by printing money to finance government expenditure at home, we have a hike in almost all prices including that of agricultural commodities.
What is the true story? I think a bit (or a lot) of both. Sri Lanka being a net food importer is directly seeing the impact of these increases. The poor in particular who spend most of their earnings on foodstuff are really feeling the pinch. This is on top of more than 20% inflation even without food prices factored in (food inflation stands at about 34%) due to loose monetary policy by the central bank as a result of financing unsustainable government spending.

A pertinent question to ask is whether the high price of rice in particular, which didn't have much interaction with the global markets until recently be explained by generally high inflation alone. General inflation is probably the driving factor, but somehow I don't think captures the complete picture. It's possible there is an increased demand locally for rice due to people abandoning close substitutes like bread given the high price of wheat.

Now I'd love to see some numbers supporting that, something which is unfortunately sorely lacking in Sri Lankan media.

Related articles on food prices:


nouhad said...

Interesting read

aadhavan said...

isn't it possible that with the mess in the mortgage markets spreading and infecting financial markets across the board, investors are putting their money into commodities, thus driving up food and oil prices. I may be mistaken, but gold prices jumped suddenly during the initial shocks felt during the sub prime mess. wonder whether there's a connection? or are food markets not susceptible to speculation?

Deane said...

Yup, that's (in part) what some low-interest rate guys are arguing.

How the Fed handled the suprime mess and the financial crisis was injecting even more liquidity into the markets by lowering interest rates, result is inflation and a weaker dollar.

This also leads to speculation of even further weakening of the dollar and they invest in, among other things, in commodity futures markets, which does indeed include food.

The hike in gold prices, ditto.

That's why I think the picture is incomplete without the monetary explanation, unless someone is arguing Indians and Chinese are eating more and more Gold in the past few months, obsessively.