Wednesday, November 21, 2007

[PBN] Food for thought as prices soar


Economic Outlook
David Smith

SO many potential subjects this week. There was Mervyn King's Northern
Rock interview and the kerfuffle at the Treasury when he said Alistair
Darling had the final say (on King's recommendation) in not supporting a
Lloyds TSB takeover of the troubled bank.

There was the Bank of England's decision to leave interest rates at
5.75%. And of course there was that pesky oil price, whose flirtation
with $100 a barrel was enough to push a litre of unleaded above £1 for
the first time. I remember my dad filling the entire tank of our elderly
Hillman with leaded petrol for £1.

I'll come back to the Bank and oil. But I want to fulfil a promise by
writing about something else that is rising strongly in price, food.

Food prices in dollar terms are up by more than 30% on a year ago,
according to the Economist commodity-price index. The rise in sterling
and most other currencies is less, but still significant.

Associated British Foods, one of Britain's biggest food manufacturers
and owner of the discount fashion chain Primark, says prices for four of
its most important food commodities – wheat, corn oil, malting barley
and dairy products – have doubled in a year.

In some countries such as Mexico and Italy rising prices for staple
foods have become a hot political issue. In all countries they have
complicated matters for central banks. "There's little central banks
around the world can do to prevent food prices from rising," Mexico's
central-bank governor, Guillermo Ortiz, said last week. Mexico has just
raised interest rates, as has Australia, in response to the
commodity-price boom.

Analysts at Credit Suisse First Boston point out that German food prices
are up nearly 5% on a year ago and will push euroland inflation to 3% in
the coming months, which could prompt a further rate rise from the
European Central Bank. As a frequent purchase, rising food may have more
impact on people's inflation expectations than other goods.

In Britain, food prices were up by nearly 4% in September compared with
a year earlier, but milk, cheese and eggs prices rose 6% in that month
alone and margarine and butter were up 15%.

Why are food prices rising so strongly? They are highly volatile, driven
by the success of harvests, weather conditions and other short-term
factors. A shortage one year is often followed by a glut the next, as
farmers respond to the price signal and plant more of the crop for next
time. So a sharp rise in food prices in 2000-1 was followed by years of

Much of the analysis of current high food prices confuses these
short-term factors with longer-term trends. So the sharp rise in China's
inflation to more than 6%, a 10-year high, is not due to the fact that
Chinese consumers have suddenly discovered meat. It has more to do with
the fact that pork supply has been hit by a nasty outbreak of blue-ear

The Chinese, in fact, are already big meat eaters, with average
consumption per head close to that of Britain, and not far behind
America. Half of the world's pigs, after all, are in China. This is not
to say that rising prosperity will not increase China's protein
consumption – it will – but it is not happening overnight.

China, with 20% of the world's population but only 7% of its farmland,
much of it poor quality, is perhaps the least appropriate nation to be
developing a greater fondness for meat. As Jing Ulrich of JP Morgan
pointed out last week, much of China's production of corn and soyabeans
goes for livestock feed. It takes 5kg-7kg of grain to produce 1kg of pork.

A recent report from UBS, What's Up With Food Prices, does a good job in
disentangling short-term from long-term factors. "While rising Asian
affluence or climate change are likely to have important influences on
food prices over time, recent price jumps appear to have more in common
with historic factors, such as poor harvests or animal disease, than
they do with 21st century phenomena," writes Larry Hatheway, the
report's author. "Even demand for biofuels appears to have had only a
modest impact on prices."

This is confirmed by figures from the Department for Environment, Food
and Rural Affairs (Defra). Only 2.25m tonnes of wheat, 1.5% of EU
production, will be used globally for bioethanol production in 2007-8.

Even so, some long-term trends – a rising population of affluent people
in Asia, a gradual increase in demand for biofuels and the impact of
climate change – point to rising food prices over time.

There is an echo in some current analysis of the fears of the early
1970s, when the Club of Rome think tank warned that we were heading for
a Malthusian crisis of insufficient food to feed the world's growing
population. But, without going too far down that route, there will be
significant pressures.

There is also an important interaction between the high price of oil and
higher food prices. Expensive oil adds directly to the costs of growing,
harvesting and distributing farm produce. It also increases the
incentive to turn over crops to biofuels.

Some would say we have had cheap food for too long. The National
Farmers' Union notes that, if food commodities had kept up with
inflation over the years, wheat prices would be several times their
current level. It is also true that the impact of higher food prices is
most serious in poor countries – and for poor people in rich countries.

Increases in the price of commodities account for only a small part of
the rise in food prices. Defra calculates that bread prices need to rise
by only 6% even if the doubling of wheat prices is fully passed on. Most
of the cost of the food we buy is in processing, production, labour
costs, transport and margins.

But to return to where I started, rising food prices – like the high
price of oil – are something the Bank could do without. It is possible
that these high prices will be balanced by lower prices for other goods
and services, but that is asking quite a lot.

The Bank will probably say in its inflation report this week that it
left interest rates unchanged because the downside risks to growth were
balanced by upside risks to inflation. "Agflation" – those rising food
commodities – won't give us stagflation but they could complicate
things. The danger is that internationally generated food and
energy-price increases keep inflation and interest rates in Britain too
high for comfort, preventing the Bank from responding to the slowdown.

Check for earlier Pacific Biofuel posts:

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