The MasterBlog: The agonies of agflation
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Sunday, August 26, 2007

The agonies of agflation
Rising food prices

The agonies of agflation
Aug 25th 2007

Fuel for the body; fuel for the car


SHARING pain is usually deemed a good thing. So advocates of dishing out agony will be gladdened that the wallet-crunching pangs of car drivers filling up with petrol are now equalled by the wince-inducing stabs felt by shoppers piling up their supermarket trolleys. As oil prices stay high, wheat prices hit an all-time peak of over $7.50 a bushel for December delivery at the end of trading in Chicago on Thursday August 23rd.

The soaring prices of bushels and barrels are not unconnected. The cost of agricultural commodities, just like oil and metals, has gone up sharply over the past couple of years. Aside from wheat, the prices of corn, rice and barley have all risen by over a third since 2005. Food prices around the world are rising so quickly that a new term has been coined to describe the ballooning price of breakfast staples and dinner-time favourites: agflation.

The latest spike in wheat prices has come in response to news that Canada’s crop could be reduced by roughly a fifth this year after bad weather hit the world’s second-largest exporter. This sent countries that rely on imported wheat, such as Japan and Taiwan, scampering to the market to secure supplies. Whether climate change is to blame for Canada’s poor summer is unclear but its underlying pressure on prices is in less doubt.

Demand for grain is accelerating not to feed humans or livestock but to fill petrol tanks. Compared with 2000, three-times more corn is used to make ethanol in America; distilleries that produce biofuels hoover up a fifth of the country’s corn supplies. Demand for cleaner energy in turn keeps demand for corn growing. Farmers are having trouble keeping pace with the burgeoning biofuel industry. And to produce more corn farmers are switching production from wheat and soya, pushing up the prices of those crops too.

On top of these pressures, rising prosperity in poorer countries, particularly India and China, is also lifting prices. Normally the response of the world’s farmers would be to increase output by planting on marginal land. This is happening. In the coming year the International Grains Council reckons that global grain production will hit 1,660m tonnes, some 90m tonnes more than last year. Nevertheless, demand will still outstrip supply. The wheat crop hit by Canada’s run of bad weather is likely to weigh in at 607m tonnes while demand may top 614m tonnes.

And the reverberations are felt right down the menu. As grain prices rise so do the prices of other agricultural products that rely on it as an input. As the cost of keeping poultry and livestock goes up so do the prices of eggs, chickens and other meat. Even if new land is planted this may not help to push down food prices. Because generous subsidies ensure that biofuel production is handily profitable, that industry is likely to grab new grain supplies to prime its distilling towers.

Agflation can also cause headaches for central banks. In most countries, the measures of core inflation that banks monitor most closely when making decisions about monetary policy exclude food and energy prices. Both are volatile and vulnerable to supply shocks. As central banks try to control demand they tend not to react to price fluctuations caused by see-sawing supply.

But in consumer-price indices, at least in some countries, food has a greater impact. In America food carries just 14% of the weight of the consumer-price index, but in China it accounts for 33% and in India 46%. In such countries the rising price of food obviously could push up inflation levels overall. In addition, if food prices stay high, and if consumers spend less on other goods, other parts of the economy might suffer. Good reason, therefore, for central bankers and others to hope that the pain of agflation is not shared too widely.

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