Monday, February 7, 2011

Food prices - lets talk timing before we talk about 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.


  1. I argued here that supply shock can't possibly be the sole reason. Inflation expectation has oddly correlated with various commodities prices, not just food, and it is precisely what the Fed is trying to do: drive up inflation expectation. It makes the argument that monetary policy has nothing to do with food prices surge, well, absurd.

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