#73 The Food Squeeze

The "Food Squeeze" is a global phenomenon. It doesn't matter whether you like pasta, tortillas or rice: prices are up and are set to go even further. Basic food commodity prices have been moving up steadily for quite some time now. In France alone, grain stockpiles are down to the levels of the early 1970's. Those were record lows by their own standards and therefore we are witnessing an unprecedented food squeeze. So far in Europe the effect has been dampened somewhat by the strong Euro and its relative trading strength.

There's also another, albeit temporary cushion that lies in the use of commodity based instruments and derivatives such as futures and forwards. Major food firms such as ADM, Cargil, General Mills, Kellog and Phillip Morris employ these hedging instruments to protect themselves against cyclical spikes associated with the volatility of commodity markets. For consumers it creates a delaying effect, which means that in many cases you don't feel the immediate hike in food prices - at least not as fast as energy prices.

However, bioflation is going to end up on everybody's plate at some point. Part of the food squeeze is coming as a direct result of the rapid industrialization of India and China. When agricultural laborers move into the city, their production output is lost from farms. Industrialization could theoretically mitigate these effects by further mechanization, fertilization, economies of scale and other capital intensive processes to ramp-up output. But that takes time and money. For now at least, laborers are choosing to go to the city rather than ramp up their own agricultural output. One would expect higher food commodity prices to be an incentive for higher production. But this is not expected to happen overnight, and things are further complicated by the bioflationary effect of a growing biofuel economy that links food prices with energy prices.

Given the sheer size of the Chinese economy and its impressive growth rate, China consumes a significant and growing slice of world wide food production. This is expected to increase in tandem with slowing food production. Net food output in China can no longer keep up with demand. As China grows and develops, its citizens will have more income to dispose on food. This increased spending power is now resonating on world markets for grains, meats and fish.

Food prices also have a stronger impact on developing countries than on developed countries. In China, on average, 34% of disposable income may be spent on food. In the U.S. this figure is less than half. Nonetheless, food prices are amongst the highest risers in core inflation figures for the USA. On a macro scale, for now this only slightly affects demand for other goods. In developing countries it remains to be seen how adversely these price hikes will affect overall economic growth. For the worlds poorest, the news could be rather bad, as the UN recently announced it could no longer afford to feed the world.

The production of food is really part of a larger structural problem, as you may or may not know/remember from your typical Economics 101 course. Food is an inelastic good: everybody has to eat and substitution is really not an option. Given the trend of industrialization, lagging production, climatic challenges and other side effects of bioflation, food prices are expected to stay in a strong upward trend. The chain is deeply inter-connected (i.e. grain is not only used in domestic consumption for bread, but also to feed pigs, poultry and other animals). This means that as prices for grain go up, so do the costs of producing meat and other related products.

With production not keeping up and inventories at record lows, the pain that occurs when China buys food "en masse" on the world market will be felt by everyone. Indirectly, this bioflation is going to add to global inflation and possibly hamper growth and development. Additionally, with higher future inflation expected, the inflation targets of central banks world wide will most likely come under renewed pressure. This ultimately means higher interest rates, and thus more expensive capital. Just last week we saw what credit repricing did to world markets. It sent shock waves throughout the financial world. If last week's "correction" was just a speed bump on the road to further economic growth (as predicted by most economists) then it would be wise to investigate what further bioflation will do to the world economy.

#72 Bioflation and the Global Eco-Hypocracy

Markets are moving, volatility is up, Forex markets are once again the focus of a broader public. However, instead of being swamped by a myriad of different analyst reports and outlooks, it could be beneficial to look beyond the complex parade, rank and file of charts in order to grasp what is happening under the bonnet of the world economy. Markets are essentially economic battlefields, continuously pulsing and pushing. The force majeure of the world economy - the dollar - has taken a severe beating. With it, volatility has come back into the market and subsequently also some repricing, so far psychologically more than in absolute yield spreads and valuation. All these things are nothing but distractions when put in perspective of the "real" hurricane out there, and that hurricane is a global one: Bioflation.

Bluntly put: Bioflation is what happens when food (that what we put on our dinner plates) ends up as fuel in our gas tanks. When the appetites of automobiles start competing for those of humanity as a result of ethanol/biodiesel mania, we have a problem called bioflation. When food crops such as corn, rapeseed, sunflower, sugarcane as ethanol or biodiesel have to compete with oil on global fuel markets we essentially interlink them on an unprecedented global scale. This has been instrumental in the increase in food commodities worldwide.

In the end the consumer pays the bill in the form of substantially higher prices for tortillas, cornflakes, cola, hamburgers and pizza. Bioflation may be good news for farmers, but not for regular consumers and the world's poor. As a result of bioflation, Mexicans have been rioting due to corn prices going through the roof. The culprit: corn being used as a source of ethanol rather than food. The result: the price of corn and other food substitutes on their way to record heights. The bad news: this is only the beginning.

When food crops become interchangeable as fuel, they have to compete with fuels such as oil. Simpleton economists would say that this is just a cyclical phenomenon and argue that, with food as a substitute, this creates more supply in a market that has very little cushion. But this extra fuel supply comes at a price: bioflation. Opec and other large exporters have enough flexibility to keep prices high. Furthermore, there is more than enough (and still growing) demand from rapidly developing countries such as China and India. So biofuels as substitutes and alternatives to the global petroeconomy are just farts in the wind. Biofuels such only be considered as a steam valve, as part of a transition completely away from a carbon based fuel economy.

Making biofuel from corn is really not very efficient and is turning the US (previously a net exporter of corn) into an importer. The price hike and volatility of corn on global commodity markets is affecting other crops and substitutes as well. The global hike in food commodities shows just why bioflation is not a welcome trend, unless you are a large scale corn farmer or an ethanol refiner. There are other non competitive, non food crops that should be considered if one really desires to shift towards a biofuel economy. Unless we are willing and capable to rise to that challenge, we will live in an inflationary and unstable world of food and energy substitution.

Several UN organizations have already signaled that they are unable to feed the world with the current trends in food prices (as if they were able to feed the world before). However, food prices are not expected to go down as long as they remain connected to the world's energy economy. As global oil output declines and the prospect of food for oil substitution remains an alternative, high food prices are here to stay, and with it hunger on a unprecedented scale.

The cycle is more vicious and cynical than you think: besides high gasoline prices at the pump, fuel for heating and cooking also becomes more expensive. In developing countries this results in increased wood and shrub poaching and increased deforestation. Higher food prices are also going to encourage increased encroachment on existing forests as villagers look to cultivate more land. As peasants cut down local shrubs and trees for fuel, they are also destabilizing the fertile top soils in the surrounding land. Indirectly, high energy prices will lead to increased soil erosion, drastically affecting the fertility and agricultural output of the land.

Bioflation thus leads to a vicious cycle of higher food prices, inflation and lower "real" economic growth. Furthermore, the collusion of the above factors also inherently exacerbates poverty. Therefore, by understanding the dynamics of bioflation, we need to consider the trade off between "biofueling" the economy and empty stomachs world wide. As such, by "biofueling" our mobility, we drive the most vulnerable participants of the world economy into deeper poverty and hunger.

The "inconvenient truth" is that we are heading towards a world where food prices will be held hostage by both higher energy prices as well as global warming. Additionally, in a very perverse way, the Saudis, Putin and Chavez are more capable of determining the price of a big mac than McDonalds itself. Biofuels as the corner stone for energy independence is a green myth that will lead us down to a greater state of (inter)dependence that we cannot even begin to comprehend.

Furthermore, the effects of "bioflation" are not experienced in homogeneously. The effects, although generally detrimental to all, will be different for low income families as opposed to higher income families across different economies and geographical regions. For example, a Mexican laborer just above the poverty line may find him or herself quickly below the poverty line as wage rises don't stay in check with food prices. Bioflation will impact developed economies and families in a higher socio-economic strata as well. On a macro level this will imply lower spending on durable goods which in the long term can shift the global economy itself. For that reason the quest for cheap alternative energy is the most direct challenge of the 21st century, for it determines the fate and prosperity of mankind.

note
* non-food commodity based plants such as jatropha do offer a viable solution as biofuels because they do not directly compete as foodbased output or as food substitutes
* the author is NOT an anti-environmentalist nor a climate change denier