Rice Crisis: The Superman Effect And Modern Agriculture

``Everyman who hoards does it for his own protection; yet by hoarding he aggravates the very condition that started his fear.”- Irving Fisher in “Booms and Depressions”

The “superman effect” intensifies as governments around the world step up interventionist measures.

Aside from throwing of more taxpayer money and other market distortive policies as a stopgap to the ongoing rice shortage, the arrest of so called “hoarders” a.k.a economic saboteurs becomes one good political photo op- the portrayal of government in action or the superman effect in motion- of course, coming at the expense of private property.

Where government fails, we the citizenry pays.

Calls for even more subsidies, an end to liberalization, extension of agrarian reform and disallowing imports by leftist groups is like closing the barn door when all the horses have left. From a hindsight perspective, everyone seems to know how to resolve this predicament, especially in using public funds, yet none of them seems to have foreseen this.

Although like the rest of the commodities from oil and energy to precious and base metals to other agriculture products, the story of the rice crisis is principally an offshoot to the seeds of global monetary inflation and its accompanying imbalances and the overinvestment-underinvestment cycle mainly underpinned by the unintended consequences following years of massive government manipulation of the marketplace.

This noteworthy observation from Professor Michael Pettis of Peking University's Guanghua School of Management wrote, ``Inflation is not just a Chinese concern, of course. It seems to be a rising problem around the world, especially in countries that intervened regularly in the currency markets to promote mercantilist export policies. This is more evidence, I think, that my theory that the recent policies among several developing countries, aimed at protecting them from the threat of another Asian-Crisis-style meltdown, may have simply transformed one kind of balance sheet mismanagement into another kind. In their determination to protect themselves from one kind of unstable balance sheet, they seem to have constructed a different, but equally unstable, kind of balance sheet.” (underscore mine)

Prescribing more interventionist palliatives is like giving more alcohol to an alcoholic; it will satisfy the temporal desires of the inebriate, but worsens his physical condition.

Remember, land is a constant factor. So, while subsidies may serve as panacea, the impending crop substitutions emanating from the incentive shift from these policies will mean possible shortages of other crops or other items/produce that depends on land for output in the future.

One may argue that at least such measures may not be as politically destabilizing or that the opportunity costs won’t be politically sensitive in nature, but for us these suppositions signifies imprudent assumption. The impact from these asymmetries will be seen later, perhaps through other channels or through output changes and whose political implications are likely to be unanticipated.

Modern Agriculture Requires Market Pricing Efficiency

Yet, decades of “self sufficiency” programs have not met their desired goals primarily because the efficiency of price signals has not permeated into the marketplace via productive capital investments.

Domestic farmers have not been able to increase productivity and output and manage risk because they have been entirely dependent on middlemen and traders or the government (through the National Food Authority) for price information and as exclusive buyers of their produce, thus have been shielded from the market pricing signals as discussed last week.

An organized commodity futures market would have been a primary conduit for such price mechanism transmission, which soberly said, we don’t have. Thailand’s Agricultural Futures Exchange is one such example of a productivity enhancement for its farmer constituents.

Figure 1: IMF Weather Derivatives: Strong Growth

If developed countries have utilized futures and derivatives markets to hedge for ‘weather conditions’ shown in Figure 1, example CME’s weather derivatives and Weekly weather futures, why shouldn’t we provide our farmers financial sophistication through risk management market facilities which should enable them to increase productivity and output, reconfigure the present inefficient trade structure and to even provide for insurance?

Just to give you an idea on weather derivatives, this from IMF (highlight mine), ``Weather derivatives offer a way for producers vulnerable to short-term fluctuations in temperature or rainfall to hedge their exposure. Exchange-traded contracts are typically linked to the number of days hotter or colder than the seasonal average within a future period…Weather derivatives are now complemented by weather swaps and insurance contracts that can be used to hedge adverse weather and agricultural outcomes. Governments in some lower-income countries (for example, India and Mongolia) now offer crop and livestock insurance as a way to protect their most vulnerable farmers. Ethiopia pioneered drought insurance in 2006.”

In short, profits or incomes by both farmers and investors alike can be optimized while inversely mitigating losses by the use of such sophisticated “price based” financial instruments without the needless involvement of added taxpayer funds. Greater productivity ensures adequate supplies. This is the modern approach to develop the agricultural sector over the long term.

Fiscal Impact of Subsidies

Last week we excerpted from a leading newspaper an estimate of the food component to the Philippine Consumer Price Index as only 13.5%. Apparently this turns out to only account for select items, and not the broader food basket as shown in Figure 2.

Figure 2: Financial Times: Unbalanced Diet

From the Lex column of the Financial Times (highlight mine), ``In the Philippines, a country that spent years turning round its fiscal deficit, the rice subsidy is expected to reach $520m this year, according to the Asian Development Bank, about 1.5 per cent of state spending. Indonesia will cough up a whopping $2.2bn for food subsidies – about 3 per cent of expenditure – according to the ADB, almost three times the size of earlier estimates. These subsidies add an estimated 0.4-1.7 per cent to the fiscal deficit as a percentage of gross domestic product in the Philippines, Indonesia and India (including off-budget items). If sustained, the measures will dent fiscal balances and raise the spectre of higher funding costs for governments. This will be most painful for countries already forking out on big fuel and fertilizer subsidies, such as Indonesia and India. There are other drawbacks. Most worrying is inflation – the very beast governments are seeking to tame.”

As the chart shows the Philippines appears to be the most price sensitive to food (see right chart) in the region with over 40% share of the CPI, thereby subjecting us to higher security and political stability risks. The series of attempts to pour taxpayers money to the present crisis seems to be a desperate reaction out of fear and another act of political survival.

A Possible Strain To the Philippine Peso

As the Financial Times observed, subsidies will pose as an additional burden to the country’s balance sheets and weigh on the fiscal conditions (which have seen a marked improvement-see left chart) that could lead to increased financing costs at the expense of the business climate. All of which could signify a strain on the performance of the Philippine Peso.

Again this is to emphasize that the Peso’s performance will be relative to the degree of social spending by the country whose national currency the Peso is compared to.

For instance, while Asia and emerging markets are trying to address the heightening political risks from rising food prices by increasing regulations and restrictions on food aside from massive subsidies, the US is undergoing the same process of imposing more regulations and providing of more subsidies (monetary and administrative) but aimed at alleviating or cushioning the economy from a risk of depression and from a financial meltdown.

So while both countries are engaged in currency debasing (protectionist) programs, they represent distinct political objectives.

Thus, the divergent scale of the interventions in support of these objectives will likely determine the relative price values of their currencies.

Higher Interest Rates and More Currency Arbitrage?

Likewise, we are told by the administration that despite the drastic and dramatic increase in expenditures to meet such contingencies, they will try to “balance the budget”.

This implies sacrificing other parts of social spending such as prospective infrastructure investment programs. This diversion of funds is likely to negatively impact the country’s economic growth prospects.

Figure 3: Asianbondsonline.com: 2 and 10 years Local Currency Yield

With consumer price inflation rising to its fastest pace in 20 months to 6.4% from last year (which we have been expecting), present monetary settings brings us deeper into a negative real rates.

As we have repeatedly said, negative real rates will likely trigger more speculative activities as the search for the alternative monetary function of “store of value” intensifies. This further reinforces more “inflation” within the domestic economic and financial system.

So we may likewise expect the domestic central bank, the Bangko Sentral ng Pilipinas (BSP), to raise policy rates to keep up with rising treasury yields (falling bond prices) see figure 3.

Otherwise maintaining present rates amidst surging consumer price could lead to negative real rates across the entire yield curve, which should further aggravate the opportunity costs of holding cash.

On the other hand, rising yields could lead to resurgent foreign capital portfolio flows predicated on currency yield spread arbitrages or carry trades.

It is a wonder; could last week’s reemergence of foreign capital flows into the Phisix, the largest since the last week of December 2007, signal the return of foreign capital? While it would be hasty to interpret a data of one week as a future trend, these developments are certainly worth the look.