Tuesday, 8 February 2011

The food price shock - lets talk timing before we blame the weather

Over the weekend, I wrote a post on the recent surge in world food prices. Happily, it turned up as a link on a number of websites, so was one of my more widely read pieces. The post argued that the recent food price shock was primarily due to the world wide decline in interest rates.

This isn't a terribly popular view. The prevailing wisdom says that world food markets have undergone a radical structural change. On the demand side, Asia is growing, both in economic terms and waist bands. The continent is munching on burgers and pastries and it now firmly on the road towards obesity; a path that Western economies have been treading for nearly half a century.

There have also been a couple of well publicised supply problems. Certain commodities, such as sugar, and to a lesser extent, wheat have suffered bad harvests. As a practical matter, most of these shocks have been quite recent are therefore likely to affect future rather than current supply. Nevertheless, these poor harvests have been described in apocalyptic terms. The end times are near, and judgement day will soon be upon us. Climate change has wrecked agriculture from the Russian steppe to snowy mountains in Australia.

To summarize, there are three parts to the conventional view; higher world demand, supply shocks, and climate change. How seriously should we take these arguments.

Lets pick the easiest off first - climate change. I am fairly agnostic about whether the world is warming up. I just don't know. I am not a meteorologist. Nevertheless, I know one thing. This process, if true, will take many decades. Climate change won't burst upon us in six months and wreck our food supply.

The Asian demand argument is also unconvincing. Why? Take a look at the chart above. It traces out the UK CPI price index for all food items, divided by average earnings. This chart tells us how much food costs in terms of the price of UK labour.

The chart tells us that between 1996 and 2007, food in the UK became a lot cheaper relative to labour. There could be some honest debate about the precise turning point. Nevertheless, the chart points out that food prices rose sharply relative to UK wage rates as soon as the financial crisis took hold. So where is the Asian growth story in this picture. I would say it isn't there. Asia was growing rapidly throughout the decade before the crisis and food was becoming cheaper; much cheaper.

Now, I know that this chart is picking up a lot of other things; like the sterling depreciation, and the recession. My point is just about timing. Just to make that point one more time, could Asian growth explain that chart.? Could the weather in Russia or the floods in Australia? Call me a weathergirl, but I don't think so.

The last argument - the supply shocks - is the most difficult. There have been shocks, and prices should rise in response. The issue is one of magnitude - should these shocks have generated double digit increases? All commodity prices are on the rise, including those that have experienced no such supply shocks.

Supply shocks are in the mix, but it is monetary policy that is baking the inflationary pie. There is lots of liquidity pouring into commodity markets. Speculators are doing their thing; responding to incentives, and trying to turn a buck. Meanwhile, the rest of us are paying more for our food.


Robert Dudek said...

I think that there is a confluence of factors, but Asian growth could still play a role.

Growing Asian food consumption could have hit some kind of critical level, which then manifested itself as a sudden emergence of higher food prices.

But overall the main culprit is devaluation of the western currencies. I wonder what your chart would look liked priced in gold?

Anonymous said...

You say commodities, that haven't experienced supply side shocks have also experienced a price increase, you are however disregarding the effect of substitution. If the price of coke triples, I and most others will end up buying more substitues, like fanta for instance.


Jim said...

You cannot discount the fact that at around 2008 the use of grains for bio-fuels became physical reality. The policies had been in place for several years previously, but the production plants were only just coming online. The EU set a target for a % of bio-fuels to be included with fossil fuels - this target is only now being achieved. Unless the policy is changed, thats a considerable chunk of food production that's not available for eating.

Chuck in the Western States starting to print money around the same time, several big harvest failures, the prospect of higher demand from Asia, and the rise in food prices is easy to explain.

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Tomrat said...

And Alice as I linked to Tim Worstall's article at the ASI in your original piece the jury is pretty much in as to the usefulness of speculators in mitigating MAJOR supply shocks, though I would concede that you are dead on the money when it comes to low interest rates not helping; my guess is that this is exacerbating the problem at the extreme poverty end of the spectrum all the way up to those living on fixed incomes - costs going up relative to debt repayment/interest on savings etc.

Problem is as interest rates as with the money supply are central-bank controlled, we are unlikely to see this particular needle grasped.

james c said...

What is the mechanism by which low interest rates are meant to increase food prices?

LetThemEatCake said...

James C.

The low interest rates (and the QE) mean that people cannot get high returns on their capital unless they invest in some bubble that isn't bursting. The idea going around is that commodities are the current bubble of choice. So investors ( aka speculators ) are playing monopoly with basic foodstuffs which is leading to higher prices. The contrary argument seems to be that speculators do a good thing because they drive up the price of things in short supply whereby intending purchasers buy something else until supply and demand are matched. The downside is that poor people - particularly those who spend a high proportion of their income on basic foods are being starved.

I seem to recall reading once that more governments have been overthrown because the price of bread went up than any other reason.

Tomrat said...

LetThemEatCake & james c,

LTEC is indeed right, though I am not sure if they are suggesting speculation is a bad thing or not; if so then I disagree and here's why.

They are actually two groups of pricing at play here: food commodity prices & money supply, the latter being inversely proportional roughly to interest rates.

As a consequence price signals essentially indicate at the moment quite a simple message: "BORROW BORROW BORROW!" Ultimately this is where LTEC's speculators come in, chasing any bubble they can find to turn a buck in the face of a rapidly declining returns on investments thought safe over the last 2 decades.

Who's to blame? In my view blaming speculators is redundant, akin to blaming a cheetah or running fast or a cow from chewing cud; we all react instinctively to THE EXACT SAME SIGNALS; why would we have accumulated so much debt over the last 2 decades otherwise?

Ultimately we are reacting to false signals sent out by politicos and central bankers with a collective bent to making us think we are prosperous, hence keeping them in power.