"Silver Lining in High Food Prices"

Kenneth Rogoff says higher commodity prices send important economic signals that shouldn't be muted:

Silver lining in high food prices, by Kenneth Rogoff, Project Syndicate: Today's soaring commodity prices scream a fundamental truth ... that many politicians, particularly in the West, don’t want us to hear: the world’s natural resources are finite, and, as billions of people in Asia and elsewhere escape poverty, Western consumers will have to share them. ...

The United States’ ill-considered, biofuels, subsidy programme, demonstrates how not to react. Rather than acknowledge that high fuel prices are the best way to inspire energy conservation and innovation, the Bush administration has instituted huge subsidies to American farmers.... Never mind that this is inefficient in terms of water and land use. ...

[D]iverting vast tracts of agricultural land into fuel production has contributed to a doubling of prices for wheat and other grains. With food riots in dozens of countries, isn’t it time to admit that the whole idea was a giant, if well-intentioned, mistake?

Another wrong turn is the proposal ...to temporarily scrap taxes on gasoline. As laudable as it may be to help low-income drivers deal with soaring fuel costs, this is not the way to do it. The gas tax should be raised, not lowered. ...

Of course, it isn't just the cost of oil that is high, but all commodity prices... The proximate cause is a global economic boom... Some politicians ... complain about speculators... But why is this a bad thing? If “speculators” are bidding up today’s commodity prices because they realise that future generations are going to want commodities too, isn’t that healthy?

High prices for commodities today mean more supply for future generations, while at the same time creating an incentive to develop new ways to conserve... Again, high prices are helping in ways that Western politicians seem afraid to contemplate.

While surging commodity prices are helping poor farmers and poor resource-rich countries, they are a catastrophe for the urban poor, some of whom spend 50 per cent of their income on food.

One element of the solution is to compensate the very poor for the higher cost of survival. Over the longer term, more money for fertiliser, and other aid to promote self-sufficiency, is also essential.

Comments

[ken melvin]

Doubt that surging prices are helping poor farmers much anywhere. Markets can be a powerful tool, but wise they ain't. And, why not extend the price of oil to include its replacement cost while we're at it?

[Organic George]

Yes, biofuels are the key driver in inflated Ag commodity prices since this links food to energy prices.

However the hedge, pension and commodity funds are to blame for the outrageous volatility in Chicago pits. This volatility is beyond anything seen in modern history, so much that farmers and grain elevators can no longer use the CBOT to hedge their crops. A problem the CBOT is trying to address but is at cross purposes. They want to keep their "purpose" as a risk hedging mechanism but love the high volatility created by the funds.

So the basic premise of securing future Ag products due to high prices is flawed by the facts.

[blackswan]

Organic George nailed it. A farmer who can no longer afford to hedge is just one weather incident away from being out of buisness. It would be easy to drive commodity prices lower. Just raise the Fed funds rate to 7%, then watch all those hedge funds deleverage. The US would finally get the economic correction it's been dodging since 1998. It would mean blood in the streets, but in the long run, we will have blood in the streets anyway. Then, every city will be Vallejo, Ca.

[blackswan]

Lipsky is first managing director of the IMF.

"``Low interest rates have a statistically significant impact on commodity prices'' according to preliminary evidence, the IMF official said. ``Exchange-rate shifts also appear to influence commodity prices.''

$25 Cheaper

IMF research indicates that if the dollar hadn't fallen from 2002 to 2007, oil prices would be $25 a barrel lower. Crude futures surpassed $120 a barrel this week for the first time. Commodity prices excluding fuel would be 12 percent lower, Lipsky said."

[reason]

blackswan...
What a strangely US centric comment. I earn in Euros, thank you very much.

[trader walt]

"Organic George nailed it. A farmer who can no longer afford to hedge is just one weather incident away from being out of buisness."

Please supply data to support your argument. Judging by the price of midwest farm land and ancedotal evidence from farmers, high grain prices are resulting in higher farm incomes.

[trader walt]

Oops! I missed the point of the aggument. My bad!

[blackswan]

"What a strangely US centric comment. I earn in Euros, thank you very much."

Reason, what does that have to do with anything. If dollar denominated financial vehicles kicked out higher yields, speculation money would be pouring into them and out of commodities. Funds that hedge commodities would deleverage. That would bring the prices of commodities down.

Oil is denominated in dollars, and its price increase is causing push cost inflation on most other commodities. This even hurts people who are paid in Eruos.
________________________________________________
trader walt says: "Please supply data to support your argument."

tw, I hope this will suffice.

http://www.nytimes.com/2008/04/21/business/21cnd-commodity.html?_r=1&hp&oref=slogin

[reason]

This even hurts people who are paid in Eruos.

Why exactly? If prices denominated in USD are rising, but not prices denominated in Euros I don't understand the logic of the comment. Read Dean Baker about this. The falling dollar hurts people who earn dollars. But given that the US has been running huge trade deficits for years (and so suffering a net drain of wealth) and needs to reduce net imports this change in the terms of trade is something that needed to happen. (Ever heard of global rebalancing?) Now I happen to believe that commodity prices are being pushed up somewhat by speculation, but more by actual shortages. That low US interest rates and a falling dollar make this worse in the US is tough for the people living there. But they have been living beyond their means for years, and this is the pay back.

[trader walt]

Farmers, like all hedgers, have always had to deal with basis risk. Futures are an imperfect hedge. Inadaquate funding to manage hedge risk can compound the problem for any hedger. One problem is that some farmers are not good risk managers. Yes, volatility is up, but crop prices are way up compared to a few years ago.

Ask a John Deere dealer how business is the next time you pass a dealership.

[blackswan]

"Now I happen to believe that commodity prices are being pushed up somewhat by speculation, but more by actual shortages."

Oil was $25 a barrel in 2003 and is now $120 a barrel. So, reason, you believe that the price of oil is up almost 500% in five years because of "actual shortages" (I assume you mean supply and demand pressures). Think again, reason. Also understand that the Chinese are buying more rice to offset the falling value of their USD reserves. Thus driving up the price of rice throughout much of the world.

http://www.alternet.org/audits/83345/

By the way, reason, do you believe US drivers are paying more for gas than European drivers? If so, think again. How much more gas are European drivers using than they were five years ago? Is your price increase really because of supply and demand? Is oil priced in dollars. See if you can piece everything together, and you might find that when the USD is the world's currency, a weak USD affects the world.

[blackswan]

trader walt, the American farmers have been suckered into leveraging their appreciating land and buying too much equipment, before. Now they will have lots of company, since it looks like the many of the world's farmers are falling into the same trap.

[reason]

So, reason, you believe that the price of oil is up almost 500% in five years because of "actual shortages" (I assume you mean supply and demand pressures).

We have discussed this before. My position is the same as Paul Krugman's. If speculation were driving the price increases then stockpiles will increase. In fact they haven't.

By the way, reason, do you believe US drivers are paying more for gas than European drivers?

??? Is this relevant given the huge difference in tax? European drivers have seen much lower percentage increases than American drivers, which is what you would expect.

Also understand that the Chinese are buying more rice to offset the falling value of their USD reserves.

This only makes sense if they think that rice production won't be increasing much in the near future. i.e. Supply and demand pressures.

[blackswan]

reason says: "If speculation were driving the price increases then stockpiles will increase. In fact they haven't."

That would only be true if speculators had to take delivery. Then again, if speculators had to take acutal delivery, oil prices wouldn't be this high. Do you really think ETF buyers and hedge funds are stockpiling the oil they are hedging?

reason said: "Is this relevant given the huge difference in tax? European drivers have seen much lower percentage increases than American drivers, which is what you would expect."

From what I can see, the Germans are paying around $5.50 after suptracting fuel and VATs, where as the Americans are paying around $3.05 after subtracting state and Federal taxes. What you stated does not explain the discrepancy.

[me]

"Ask a John Deere dealer how business is the next time you pass a dealership."

Not good in Indai, farmers are swithcing back to Camels.

[me]

"Oil was $25 a barrel in 2003 and is now $120 a barrel. So, reason, you believe that the price of oil is up almost 500% in five years because of "actual shortages"

What exactly is the relevance of that to the price in Euros? I don't think the price of oil is up 500% in terms of Euros. Why do you think the oil producers are switching fro the dollar to the Euro? so they don't lose value holding dollars.

If you don't believe it is s supply problem then please explain why Saudi Arabia, Venezuela, Mexico, Russia, Indonesia, US, Norway all produce less oil than say 3 years ago?

What is so hard to understand about shortages? Do you really think it is speculators in the rice market? My goodness, Myanmar's whole rice production got wiped out and the little that didn't has no power to process.

South Africa will have no solution to their power problem for 5 years so they have to continually shut down mine production and you think there are no shortages?

I think reason is right on this one.

[mikx]

the world’s natural resources are finite, and, as billions of people in Asia and elsewhere escape poverty, Western consumers will have to share them. ...

Why? Why we have to share resources?

States fought wars over resources through history.
We still have big armies that thirld-worlders cannot match.
Why must we share?
Because totally out of touch rich and comfortable elitists say so?

We share out of goodness of our collective heart, we don't have to do it.

[Patricia Shannon]

The Southeast U.S. has been in a drought. When the Republican governor came into office, he discarded plans by the previous Democratic administration to prevent water shortages, which were inevitable, due to the growth in population and periodic droughts, even w/o global warming. So now we are having the predictable water shortages, and our Republican leaders are fighting to be able to use up the water in rivers that go thru the state, rather than leaving some for Alabame and Florida. And now they claim they should be able to annex part of Tennessee that includes the Tennessee River, because of a surveying error more than 100 years ago. Then Georgia could bleed the Tennessee River dry w/o regard to states down river.

I see now why there used to be wars between cities (much less states). If it weren't for the federal government, there might be a real possibility of eventual wars between southern states over water.

[BrotherMaynard]

Liquidity chases the appreciating asset. Since real estate is virtually off the table, IB's (among others) have no place to grow capital other than via commodities.

Paper demand is infinite. Short sellers (arbitrageurs) have been chased out of the market simply b/c of the devastating effects of margins calls given the rapid influx/buying of commodities futures. Make no mistake, futures markets were not designed to handle this much speculation. They were designed to serve as a hedge for producers (exxons) and consumers (refiners). Speculation was always needed to provide liquidity, but it was arbigrageurs that would keep speculation in line (usually shorting if prices were too high). In this case, there isn't a significant amount of short capital willing to "arb" prices back down. In effect, a negative feedback loop has been created -- not dissimilar to the one we just had in housing (or in the NAZZ in 1999).

"Somtimes too much liqduidity is a bad thing." (to quote the interfluidity blog)

I also urge you to read this analysis - not authored by me - (there are three parts...the pasted link is to part 3): http://www.marketoracle.co.uk/Article4526.html

[blackswan]

BrotherMaynard,

You are exactly right, Brother. The corporate bank vampires, along with the sovereign wealth and hedge fund rentiers, are sucking the real life out of the productive world through non-productive financial engineering.

[Jack]

It's not just the urban poor who are suffering from high commodity prices, at least in America. Going on thirty years of high republicanism has eroded the living standards of the middle class and has gone a long way to shredding the social safety net. Unless we want to go with a Malthusian alternative (and there won't be a few economists arguing for just that), then it looks like it's time to soak the rich. Don't worry though, I'm sure they'll be fine. They're a pretty resilient bunch.

[reason]

blackswan...

That would only be true if speculators had to take delivery.

So I assume you believe there is a huge difference between futures prices and spot prices as producers find there is no one to deliver to? If what you are saying is true, you should still see it in the market as producers produce more than there is end demand for.

[reason]

Look Blackswan - very recently there has been a difference between futures prices and spot prices for grain. And it has discouraged real producers from using the futures markets, which worries the futures markets a lot. In the oil market the relationship varies over time being sometimes positive, sometimes negative. But the futures market is not totally divorced from the reality of the spot market. Even if you roll over a futures contract, you have to find a counterparty.

[reason]

blackswan
Re fuel price - I don't understand what your point is, but if the discrepency is that big I would be concerned if I were you have forgotten something in your calculation.