Thursday, June 5, 2008

Implications of rising global food prices

Here is a good summary of the implications of rising global food prices:

It sounds tautological to suggest that higher food prices are contributing to inflation, but the importance of this relationship cannot be overstated. In virtually every major country and region, inflation is approaching dangerous levels. In the Euro-zone, it has already notched a 15-year high. In China, a 12-year high. In Vietnam, the inflation rate has soared to 21.4%, and in Zimbabwe, prices are rising at a whopping annualized rate of 1,000,000%! Even in the US, where food represents only 15% of the CPI basket, consumers are feeling the squeeze. The CPI currently stands at 3.9%, well above the Fed’s comfort zone. Furthermore, the minutes from the Fed’s April meeting suggest that economists are not confident that inflation will return to an acceptable level prior to 2010.

Monetary Policy:
The spike in food prices could not have come at a worse time, since the global economy is struggling to deal with another crisis, this one related to housing and credit markets. As we reported in a previous article, inflation is hamstringing Central Banks, who would otherwise use monetary policy to soften the impact from the credit crisis. At the expense of price stability, the Fed has already cut its benchmark interest rate by 3% since August. It is unlikely to cut rates further. The bank of England has also probably stopped cutting rates, despite making only one rate cut, while the European Central Bank has resisted pressure to cut rates at all. Returning to China and Vietnam, both of their respective Central Banks have separately hiked rates and tightened lending restraints. In short, Central Banks throughout the world are prioritizing price stability over economic growth.

Famine and Civil Unrest:
In the developing world, rising food prices have combined with famine to produce the proverbial “perfect storm,” in the words of development economist
Jeffrey Sachs. “These places aren’t on the brink. They’ve gone over the cliff.” Dr. Sachs was referring specifically to the Horn of Africa, where the situation is especially dire because of continued civil war and political instability. Unfortunately, the same story is playing out in the darkest corners of the globe, sucking in a flood of aid experts and volunteers. Sadly, it has even been reported that devout Hindus no longer have enough food to make regular donations as part of their faith. Theoretically, the effect of rising food prices could be neutral on the developing world, where a signifcant portion of the population is still employed in the agricultural sector. Unfortunately, this has not been born out by reality. The World Bank surveyed the data and determined “that poverty increases are much more frequent, and larger, than poverty reductions. The recent large increases in food prices appear likely to raise overall poverty in low income countries substantially.” Rising food prices and shortages have predictably been met by anger and unrest in the developing world. “Food riots have erupted in recent months in Guinea, Mauritania, Mexico, Morocco, Senegal, Uzbekistan and Yemen.” Troops and armored trucks have been deployed in Pakistan, to guard and distribute a scarce food supply. In Haiti, the Prime Minister was forced to resign in response to catastrophic hunger and the Prime Minister of Malaysia seems destined for a similar fate.

Food Versus Fuel: The rapid rise in food prices has shone the spotlight on the nation’s energy policy, with regard to biofuels. Skeptics of biofuels, which are distilled from corn, sugar, and other plants, complain that not only is such fuel less efficient and equally environmentally harmful, but also that it is diverting increasingly scarce farmland away from more productive (edible) uses. According to
The Economist, “This year biofuels will take a third of America’s (record) maize harvest. That affects food markets directly: fill up an SUV’s fuel tank with ethanol and you have used enough maize to feed a person for a year.” The price of corn has already risen to a record high of $6 a bushel, and will certainly climb higher if biofuels become a more entrenched component of US energy policy. Already, the US Congress has legislated that automobile fuel contain a certain percentage of biofuel. Producers of ethanol, the most common biofuel in the US, are scurrying about trying to secure enough corn for their dozens of new distilleries. A $3 Billion ethanol pipeline, the first of its kind, is already in the works, and a powerful new lobbying network has emerged to protect the interests of this growing industry. Thus far, corporations have erred on the side of the debate that is consistent with their business models, with corn farmers and producers of biofuel fending off criticism from poultry farmers, who are irked at having to pay more for chicken feed. In short, the rise in food prices is sure to intensify the heated food-versus-fuel debate.

Increased Efficiency:
One upside of the food crisis is a renewed focus on the struggle to provide adequate and healthy food for the world’s poor. After the “green revolution” in the 1960s, food ceased to be an important political issue, and the ability of the world to feed itself was soon taken for granted. As a result, agriculture R&D budgets were slashed, crop yields plateaued, and
food aidHealth experts have lamented cheap corn (syrup) and soybeans (oil) for their role in the American obesity epidemics. If hamburgers and soda (beef and corn syrup) witness a rise in prices, perhaps poor Americans will be incentivized to switch to healthier diets.

Forex Implications:
High food prices have taken a toll on the world’s emerging markets, in the form of inflation. In addition to the previously cited examples of China and Vietnam, there are dozens of
countries that have seen inflation skyrocket in the the face of soaring food and energy costs. The Philippines (6.4%) and India (7%), to name a couple. As a result, emerging markets collectively represent one of the few bright spots for the Dollar. Due both to inflation and a trend towards risk aversion, investors have transferred funds out of the developing world. Oddly, the Dollar has simultaneously fallen against most of the world’s major currencies. Since contracts for commodities (including oil) continue to denominated in Dollars, a fall in the Dollar is often accompanied by a rise in commodity prices. Some analysts fear the Dollar’s precipitious fall, because of its effect on commodity prices, threatens to destabilize the global economy. One of the solutions would be a coordinated act of intervention in the forex markets. While such an act would not be undertaken under the pretense of humanitarian reasons (i.e. to help feed the poor), an appreciation in the USD would almost certainly lead to lower food prices.

Conservation: There is a well-known US government program that pays farmers not to cultivate their land. In addition to helping farmers by depressing the supply of certain commodity crops, the program also represents a sop to environmental and hunting groups. However, in the last six months alone, 5% of the land has been removed from the program because the economics of the situation have changed. The world’s tropical rainforests have also been victimized by the rise in food prices. Brazil, for example, had begun to achieve limited success in fighting deforestation in the Amazon rainforest. According to the
Amazon Director of Greenpeace in Brazil, however, “government measures had brought some success but that ‘what the government does not control is the economic reality. It is the economy that controls deforestation. Each time the prices of meat and soy rise so does deforestation.’

World Trade: The short-term impact of the food crisis vis-a-vis trade has been a rise in protectionism. Countries for which rice represents a staple crop, including Vietnam, Thailand, and India, have been quick to impose export bans. Other countries, such as the Philippines, have moved to criminalize “hoarding.” Their aim is simple: to ensure an adequate and affordable domestic supply of rice. In the long-term, the food crisis could provide the impetus to finally resolve agricultural negotiations as part of the next WTO agreement: “Arguably the rise in food prices should make it easier to persuade exporters to dispense with subsidies as farmers don’t need them and importers to lower tariffs as they want to dismantle barriers to letting in food.” Removing this protectionist infrastructure would theoretically alter the price signals that (poor) farmers receive, and help them to make more-informed decisions about which crops to plant. Despite the decline in cross-border movement of certain agricultural staples, though, the overall effect on world trade is projected to be minimal. Certain food-importing countries in the Middle East and Africa may experience modest increases in their trade deficits.

US Agricultural Policy:
On a related note, perhaps the food crisis will persuade the US to finally dismantle its massive system of farm subsidies. These subsidies principally benefit farmers of cotton, corn, soy, rice, and sugar, the prices have which have all surged over the last year. An elimination or reduction of such subsidies need not stem from a loss of altruism, but rather from the common sense idea that such subsidies are no longer necessary in a climate of rising commodity prices. Unfortunately, Congress is in the process of renewing these subsidies as part of the
$300 Billion farm bill. Perhaps in five years, when the farm bill is up for renewal, logic will prevail.

The world’s poor have clearly born the brunt of the food crisis, but surely some people are benefiting, right? Look no further then
agribusiness, the loose collection of interests that vastly influence the production and distribution of agricultural products in the US. Grain processors, such as ADM, Cargill, and Bungee, have reaped windfall profits, with the latter’s most recent quarterly earnings rising nearly 2,000% from a year earlier. Chemical Companies such as Monsanto, DuPont, and Syngenta have all raised their profit estimates. Mosaic, a fertilizer company, earned $520 million in the latest quarter, benefiting from a 150% rise in the price of certain fertilizers. Of course these profits do not come without controversy: “Some observers think financial speculation has helped push up prices as wealthy investors in the past year have flooded the agriculture commodity markets in search of better returns.” Naturally, the agribusinesses have pledged to use a portion of their profits to help poor countries with their food problems. was curtailed. Higher food prices have brought researchers out of the woodwork to press their case that agricultural technologies could vastly boost productivity in the developing world. “Robert Bertram, who oversees the funding for the United States Agency for International Developmen….argued that research to improve crop yields was ‘like putting money in the pockets of poor people, and I mean billions of poor people.’ ” Similarly, researchers in India are working to implement efficient water use and storage technologies, in order to ease the dependency of Indian farmers on rain and limit losses in harvested crops. On the domestic front, the rise in prices for agricultural commodities and meat, makes basic fruits and vegetables seem more attractive.
(HT: Fiona King)

Also check this one out:
Red Cross Raises Specter of Food Wars
Also, food crisis in Nepal here.