Rising Food Prices Is A Complex Issue But Driven By Mostly Unintended Consequences

``What we commonly find, in going through the histories of substantial or prolonged inflations in various countries, is that, in the early stages, prices rise by less than the increase in the quantity of money; that in the middle stages they may rise in rough proportion to the increase in the quantity of money (after making due allowance for changes that may also occur in the supply of goods); but that, when an inflation has been prolonged beyond a certain point, or has shown signs of acceleration, prices rise by more than the increase in the quantity of money... As a result, the larger supply of money actually has a smaller total purchasing power than the previous lower supply of money. There are, therefore, paradoxically, complaints of a ‘shortage of money’.”-Henry Hazlitt, (1894–1993) libertarian philosopher, economist, and journalist; The Velocity of Circulation

We came across an article where a local expert from the academia lectured on the present predicament attributing the crop of problems to “productivity”. We are likewise told that we require “investments” in research and development, the “right” irrigation, “adequate comprehension” of the needs of the farmers to reach a sustainable increased productivity.

While we basically concur with the premise of “productivity” as the root of most economic problems, the fundamental problem of the argument of “productivity” is one of abstraction, similar to politically abused terminologies of “honesty” or “truth”. To quote Ludwig von Mises in Liberalism, ``The concept of productivity is altogether subjective; it can never provide the starting-point for an objective criticism.”

On the surface the “proposed solution” looks so downright simple, easy to address, quite plausible and pragmatic to the point that it does not require an expert to make such prescription. But after all these years, our question remains, if such has been the case then why today’s quandary?

To quote the Economist (highlight mine), ``Robert Zeigler of the International Rice Research Institute, one of the driving forces behind Asia’s 1960s “green revolution” in farming, says that governments are now reaping the results of years of neglecting agricultural research, irrigation and other means to aid farmers.”

From the hindsight, everything looks easily explained. The problem here is the operating belief that current conditions can be sterilized or seen from amongst the limited variables operating under laboratory “cultured” settings.

Besides, given that we "supposedly" know what to do, these experts imply that throwing “tax payers” money to all these supposed problems will resolve the problem. You could add to the above the call for subsidies for higher quality seeds or funding for scientific cross breeding of existing strains of rice, but it seems none of these will be enough. Why?

The fact is the world is not as simple as we may perceive it to be, as there are many unforeseen factors that have contributed to the present environment such as evolving geography or climate dynamics, the intermittent occurrence of plant diseases or viruses, strained water supplies, the loss of arable lands due to natural causes as desertification or to even a sharp decline of Honey Bee population, which have been an instrumental component of pollinating world’s major crop production (sciencedaily.com)!

Knee Jerk Government Policies And Side Effects

Most importantly aside is the unintended effects from government policies.

Since global governments have practically corralled the rice markets, price signals have essentially been distorted. One can’t argue that this is signifies a “market failure” since the global rice markets have now morphed into an exclusive intergovernment activity. The recent volatility of rice prices seems to manifest of such aberration.

Yet, the present measures adopted by governments signify knee jerk reactions and does not guarantee of a sound resolution to the brewing disparity.

Governments reacting via the "superman effect" have now opted to either conserve its resources by closing its markets (for exporters) or by throwing vasts amount of taxpayers money to secure its desired outcome (for importers), without the necessary structural reforms. More protectionism and socialism would consequently lead to more resource allocation imbalances. All band aid remedies may temporarily alleviate pressures, but exacerbate or even extend the day of reckoning when it materializes. It is not the question of if, but when.

The fact that the Philippines have shielded its farmers with towering walls of tariffs over the years, which have not improved their lots (they are still marching on the streets!), seem to represent sufficient evidence of government policy failures. This has kept the incentives away from investors (remember capital investment would come from either private investors or you the taxpayer) who our expert say ought to have invested in the industry (R & D, irrigation, “aid to farmers”, high quality seeds etc…).

Since the Philippines has no organized market platform for its agricultural produce (commodity spot and futures market/s) that could have instituted pricing efficiency or delivered price signals enough to generate whether a given line of production is profitable or not, or a means from which to determine the profitable redistribution of resources to the areas in need, or a coordinative function of prices across the production and consumption structure, the present system still depends on the old traditional ways reliant on the functioning ‘cartels’ for financing and distribution, and kept our farmers in poverty bondage despite the so-called safety nets.

With inadequate infrastructure, the lack of price signals, limited access to financing, and deeply embedded ‘cartelized’ system (apparently the main beneficiaries of the subsidies), who in the right mind would invest or plunk capital into a losing proposition? Moreover, the depressed prices of the past years further worsened these conditions (see figure 2 earlier).

This is not an insulated development though, the aggregation of collective government policies aimed at providing so-called safety nets via subsidies, have induced the cycles of overinvestment and underinvestment. The agricultural subsidies of US, the Common Agriculture Policy of Europe and the rice subsidies of Japan have had an important hand in the present disequilibrium of supply and demand.

Moreover, recent mandate to promote the use of biofuels such as the US Energy Policy Act of 2005 have spurred meaningful impact to global agricultural prices.

Mr. Kevin Kerr for the Daily Reckoning makes this noteworthy comment on the unforeseen impact of the recently enacted law (underscore mine),

``Then the political light bulb came on – dimly, but it came on. The idea was to turn a key staple of our food supply (corn) into fuel and thus create a panacea for the energy problem. This was a miracle, right? Wrong. Ethanol is nothing new; it has been around since cars first rolled out of Detroit. Ethanol from corn comes at a very high price. Not only does it require several steps to turn corn into ethanol, but it requires acres more of land, fertilizer, fuel, water, etc. At the end of the day, the only thing that widespread ethanol use is doing is destroying more of our natural resources while perpetuating the myth that we are doing something about our energy problem. It’s almost criminal…

``It has become so absurd that farmers are becoming careless, throwing aside less-profitable crops like cotton and wheat.

``In addition, being overlooked are prudent farming methods like crop rotation and not growing corn on corn, or the process of growing a different crop the year after you grow corn in a particular field. The environmental statistics are staggering, too.

``In Wisconsin, for example, local rivers and tributaries have been dropping rapidly due to all of the extra water consumption - millions and millions of gallons.

In short, subsidies have fostered a seismic shift of activity towards these mandated crops at the expense of other agricultural produce. Reduced acreage allotted for other crops have diminished supplies which have caused higher prices for the latter. Moreover, the lack of prudent farming methods are likewise contributing to inferior yields and the inordinate usage of water, which has been turning out to be a long term strain on agricultural productivity (or lesser future output).

Moreover, monetary policies have had a substantial impact to the price of commodities. As we have long argued negative to low real rates tend to stimulate the public to seek a substitute “store of value” in lieu of a currency which it perceives to be losing purchasing power (or buys less quantity via higher prices).

Figure 5: Jeff Frankel: Commodity Prices and Real Interest Rates

Mr. Jeffrey Frankel provides us with the empirical evidence, see Figure 5, of how real interest rates are strongly correlated with price directions of commodities. This alternative explanation from Frankel (highlight mine):

``The theoretical model can be summarized as follows. A monetary expansion temporarily lowers the real interest rate (whether via a fall in the nominal interest rate, a rise in expected inflation, or both – as now). Real commodity prices rise. How far? Until commodities are widely considered “overvalued” — so overvalued that there is an expectation of future depreciation (together with the other costs of carrying inventories: storage costs plus any risk premium) that is sufficient to offset the lower interest rate (and other advantages of holding inventories, namely the “convenience yield”). Only then do firms feel they have high enough inventories despite the low carrying cost. In the long run, the general price level adjusts to the change in the money supply. As a result, the real money supply, real interest rate, and real commodity price eventually return to where they were. The theory is the same as Rudiger Dornbusch’s famous theory of exchange rate overshooting, with the price of commodities substituted for the price of foreign exchange.”

We have earlier been suspecting that some asset class would benefit from the recent monetary developments. Could soaring rice prices signify as the elected “store of value” for the Filipinos?

By and large, this phenomenon has not been unexpected to us, since we have been saying all along the inflationary pressures will continue to mount and reflected in disparate ways as governments inflate the system to avert a financial storm.

Possible Market Implications

What this means to markets?

It means agriculture and resource based industries remain as compelling investment themes for as long as governments will undertake socialistic tendencies to inflate the financial system to serve its political objectives.

As earlier discussed, distortive monetary policies coupled with increasing administrative regulations are likely to entail unintended effects that would be manifested in the market prices of commodities.

Moreover, demographic dynamics such as urban migration and infrastructure development will further add strains to the present disequilibrium aside from the ongoing global wealth redistribution process.

Yet, there could be other factors such as changes in weather and other imponderables that may elevate this progression in spite of the deflationary chapter in some industrialized economies.

Figure 6: US Global Investors: Share of Food in Headline CPI Inflation

On the negative side, higher food or commodity escalates the risk of social unrest which ups the security and political risks dimensions for investors; especially in least developed countries, where a high percentage share of Food relative to headline inflation as shown in Figure 6 courtesy of US Global Investors, may destabilize the peace and order situation or elicit the recurrence of dictatorship rule.

In addition, more social safety nets are likely to threaten fiscal discipline and wreak havoc or impair the balance sheets of national governments as the future need to pay off present subsidies by more taxes grows.

Since most governments will be undertaking currency debasement programs, the currency that debases least will likely rise, but all paper currencies will most probably fall against tangible or hard assets.

The relief is that the food basket of the Philippines CPI such as rice, meat, corn and flour comprise around 13.5 percent of the CPI basket, according to the central bank (Philippine Daily Inquirer).

Given the recent predicaments, the present leadership is faced between the perils of the proverbial devil and the deep blue sea.