Higher food prices, riots, shortages – what is going on?

Larry Kummer, Editor

16 years ago

Summary: Many factors are driving up food prices, but the elephant in the room is global inflation. This explains why prices are rising throughout the entire commodity complex (energy, industrial materials, precious metals, agriculture). Plus brief discussions of biofuels, long cycles of food prices, the role of government policy, and the likelihood of resource wars.

“Global Market Brief: Food Cost Crises”, Stratfor (13 March 2008) — Opening:

Global wheat prices rose by 83 percent at the outset of 2008 compared to 2007 prices. Soybean prices hit an all-time high of $14.22 a bushel in February, while corn prices rose to a 12-year high of $5.25 a bushel. The U.S. Department of Agriculture reports that global grain reserves have plummeted to the lowest level since 1960. Prices likely will not fall for some time; as a matter of fact, the International Food Policy Research Institute predicts that global cereal prices will be 10 to 20 percent higher by 2015.

I agree. We part company when it comes to the causes. (Bold emphasis added)

The recent rise in grain prices is mostly attributable to rising demand in large emerging economies – specifically, India and China – where the large middle class has an appetite for not only staple foods but meat and dairy products, which require land cultivation that offsets staple crop production. This, and the diversion of grain as animal feed, further increases the price of basic foodstuffs.

… Increased demand for biofuels is no small factor in rising prices, either. The International Grain Council has calculated that 6.5 percent of grain grown in the 2007-2008 agricultural season will be used to produce biofuel.

… Supply constraints will exacerbate the problems resulting from increased demand. While new lands for agricultural production are being added in Russia and South America, agricultural lands in Asia and Europe are being diverted for residential and industrial uses. In China, desertification and development have led to a loss of more than 6 percent of the country’s arable land in the last decade, and this trend will not abate any time soon.

Furthermore, food is just one of the many commodities affected by soaring global energy prices.

All of these things are true, but they omit two factors. First, governments have allowed grain stockpiles to decrease for two decades, as demand rises — so the days inventory has crashed. Hence any short-term problems cause immediate shortages. Consider the annual rice carrover (from the 28 April issue of the always valuable “Gartman Letter”):

2000-01 147 million tonnes, with global production of rice 399 million tonnes
2001-02 133
2002-03 104
2003-04 082
2004-05 074
2005-06 078
2006-07 076
2007-08 077 million tonnes, with global production of rice 425 million tonnes

Second, there is an elephant in the room — but governments prefer to ignore it. The entire complex of commodities prices has been rising since aprox 2002. Energy (oil, natural gas, coal, uranium). Industrial metals (e.g., iron ore, copper). Precious metals (e.g., gold, silver). Agricultural products. Copper prices are not rising because of the UG99 wheat fungus; oil prices are not rising because of corn converted to ethanol. There must be a systemic cause at work.

Also, prices of imported manufactured goods are beginning to rise. This is a lagged result of the decline of the US dollar over the past five years.

Inflation

To oversimplify, rising prices in some sectors are an early stage (or symptom) of inflation. But they are not inflation. As Milton Friedman said, inflation is always and everywhere a monetary phenomenon. It depends on Central Bank policy, how they react to rising prices in the commodity sector. Easy monetary policy can cushion the shock. However, if we get rising wages (aka “wage inflation”), then rising prices spread through the economy. As in the 1970’s, during which real wages rose.

What happens If prices of commodities and imported goods continue to rise, but wages do not? We get deflation, as many households are unable to pay their bills and default on their loans. This contraction pushes businesses into bankruptcy, defaulting on their loans and firing their works. And so the effects ripple out through the economy.

Which is worse for a high-debt economy like ours, inflation or deflation? To grossly oversimplify… The 1970’s had the “great inflation”, a bad decade for America in many ways. The 1930’s had deflation, and was the great depression. The government has tools to fight inflation and deflation. However, success is not necessarily easy, painless, or guaranteed.

Will American wages rise to keep up with the cost of living? The government has powerful influence on monetary conditions, but there are other factors. Globalization acts to cap wages in industries exposed to foreign competition (e.g., manufacturing, software engineering, call centers). High rates of immigration caps wages for affected workers (low skilled workers, computer programmers, engineers). The net result might be that wages fail to rise with inflation. That could be painful for America.

It is not all about biofuels

Was the rioting in Tibet due to China’s Yak-to-ethanol program? Let’s check the experts for agreement on the role of biofuels in driving up food prices. {quotes are from a report by Paul Schulte}

“Bio-fuels have only contributed about 10% of the current prices rise in food.”
— United Nation’s Food and Agriculture Organization

“There is no question that bio-fuels have a strong impact on corn prices.”
— Joseph Glauber, Chief Economist, US Department of Agriculture

“Rising Food prices have nothing to do with bio-fuels.”
— Angela Merkel, Chancellor, Germany

“I think bio-fuels are having an effect on food prices, and not a temporary one.”
— Shigeo Naruse, Director, Ministry of Trade, Japan

Although clearly more analysis is needed to determine the role of biofuels, prices are rising throughout the commodity complex — which implies there are systemic factors at work.

What about those food riots?

Most of the riots around the world result from rising prices for food, not insufficient supplies of food. Rising food prices make food unaffordable — in effect, unavailable — for the poor in 2nd and 3rd world nations. However, the specifics are quite complex. Food inflation to a large extent results from government policies. See these two posts for more information.

What about reports of empty shelves around the world, even in America?

Inflation has a psychological component. Goods inventories have declined as memories fade of the 1970’s great inflation. One way in which inflation manifests itself is belief that tomorrow’s prices will be higher than today’s. The result is inventory building — hoarding –at all levels. Governments (export bans). Producers. Middlemen. Households. Panic buying can empty shelves in even the richest nations, whose people have the money to build large stockpiles.

We can count on the media to feed the flames: “Load Up the Pantry“, Wall Street Journal, 21 April 2008 — Opening:

I don’t want to alarm anybody, but maybe it’s time for Americans to start stockpiling food. No, this is not a drill.

You’ve seen the TV footage of food riots in parts of the developing world. Yes, they’re a long way away from the U.S. But most foodstuffs operate in a global market. When the cost of wheat soars in Asia, it will do the same here.

Reality: Food prices are already rising here much faster than the returns you are likely to get from keeping your money in a bank or money-market fund. And there are very good reasons to believe prices on the shelves are about to start rising a lot faster.

Panic by government and large corporations can easily exacerbate the hysteria. Note this comment about the shortages of rice in the US by Dennis Gartman in The Gartman Letter (25 April 2008) — plain speaking by a expert in the commodity trading markets.

However, the very public decisions by Costco and Wal-mart regarding rice is not just borderline idiotic, it is manifestly so; it is materially so; it is shockingly, stupidly, can-you-believe-how dumb-this-is so! There is no shortage of rice in the US. There is not about to be, although Costco and Wal-Mart have created a “run on the rice bank” by doing what they did.

No matter how foolish the rumors, how destructive the hysteria,

Will government policy make things better — or worse?

Governments react to inflation not by tackling the monetary causes – which is painful – but by attempting to mute the price signal (price controls, export bans). This is self-defeating, as such measures have many bad effects.

Farmers have less motivation to increase production
Depressing prices encourages everyone to hoard, for the day prices inevitably spike up
Consumers have less incentive to curb use or shift from scarce foods to more abundant ones.

Government price distortions build upon distortions created by inflation itself.

Price signals are essential to change investment into production improvements, alternatives and efficiency gains. Inflation can distort the price/response signals causing over/under reaction to real events.

But these Government responses are logical and predictable. Every society is just 3 days away from revolution – which is what happens if food runs out or becomes unaffordable. Hard to talk about price signals when there are riots in the street, bit like talking about the value of aromatherapy when you are having a heart attack. A short term response like this is not really a big issue, provided it is only short term and then is followed by more reasoned and sensible responses (I note the idea by them for cooperation to raise food production, which is a very positive thing). Buying time is an ok tactic, provided it is only a short amount of time (if it becomes a long term policy then that’s another issue).

— Comment by Oldskeptic posted at What you probably do not know about China’s food crisis.

Long cycles

Commodity prices move in long cycles, driven by periods of underinvestment and over-investment. Commodity prices declined for two decades. Food prices are far lower than in the 1970’s, adjusted for inflation. The world has under-invested in agriculture for the past two decades, as it has in all four groups of commodities. This is common near the end of long economic expansions, during which

demand increases
stockpiles decline
surplus capacity decreases

Systems become unstable as they approach edges of their operating envelopes. Then even small disruptions — strikes, wars, weather — produce disproportionate ripples which immediately affect consumers. That means price volatility, both up and down — which makes planning difficult. Another quote from Oldskeptic:

For complex systems as utilisation approaches the maximum possible then efficiency drops and, very importantly, redundancy disappears. This means the system is now very vulnerable to even small disruptions in inputs, which can then cause much larger impacts on outputs than when utilisation was at a lower level.

Every system (biological, ecological, financial, etc) has a rate of adaption to environmental changes. Too rapid change can exceeds its capacity to adapt. Shortages and rising food prices are not an issue if they occur within the response time of our agricultural systems (i.e. 3-20 years) and our social systems (e.g., consumption patterns change).

The food issue has been around for a long time. I remember studies from the 70’s, 80’s and 90’s that predicted problems. The system has gone past maximum efficient utilisation. More and more inputs have led to lower and lower increases in outputs. Worse, arable land is disappearing (though drought, salinity, desertification, urban expansion, etc). So to even stay at the same level as (say) 20 years ago, more inputs have had to be pumped in, bringing forward the day of maximum efficient utilisation. R edundancy (spare land, stockpiles, etc) has disappeared over the last few years. So we have a system that is running flat out, well past its maximum efficiency and with little redundancy left for a perturbation.

What we are having now is a combination of disease (e.g., UG99 wheat fungus), increased cost of inputs (e.g., oil for fuel and fertilizer), drops in production (e.g, drought) on a system that has been very close to the limit for a while now. These minor input changes are having a much larger impact now than they would have had 20 years ago. Impacts are rippling from one food type to another. Wheat problems impact rye demand. Demand increases for basic foods impact meat production. And so on. Speculators jump on the bandwagon as well, adding a further positive reinforcement to the whole process. Countries are stopping their exports to feed their own people.

And so a new cycle begins.

Resource Wars

Perhaps there will be wars over resources. But perhaps not. The historical record does not strongly support the theory that resource scarcities increase violent conflicts. But wars are not the only bad effect of rising food prices, whatever the causes. A last quote from Oldskeptic:

Variability in food production (the cycles) in the past meant 2nd and 3rd world countries going hungry, as we in the rich countries out bid them for it (or even just take it as the British did to India in 1942, killing millions of Indians). For the 3rd world that is still true. But some of these countries can now bid with us for food, so that mechanism has gone for maintaining OUR cheap food supply.

For More Information

Impact of the food crisis on the world’s poor:

“Food squeeze feared as chance of U.S. drought seen“, Reuters (25 April 2008) — ” Iowa State University extension climatologist Elwynn Taylor said the corn belt has a one in three chance of drought this year.”
“The new economics of hunger“, Washington Post (27 April 2008) — “A brutal convergence of events has hit an unprepared global market, and grain prices are sky high. The world’s poor suffer most.”
“Rice price rise takes toll in Manila slum“, Los Angeles Times (27 April 2008) — ” staple moves out of reach for the poor amid expectations of shortages, increasing potential for unrest.”
“Shortages Threaten Farmers’ Key Tool: Fertilizer“, New York Times (30 April 2008)

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