From all accounts it appears that the world is in the early stages of a major leg up in food prices. The major macroeconomic trend will likely drive economic policy and the investment outlook for years to come. Although mainstream pundits like to focus on cyclical drivers like the weather, the real force behind the move is secular. The U.S. is leading the world in a pandemic of monetary inflation that is helping to cause commodity prices, food in particular, to skyrocket across the globe.
The Federal Reserve's monetary excess is currently being magnified by China's misguided currency peg policy. As the United States debases its currency through excess printing, China must follow suit. In order to maintain a consistent relative valuation, China must adopt the monetary policy of the United States.
Just last week, China announced that in the 4th Quarter 2010 its foreign currency reserves leapt by $199 billion to $2.85 trillion. The increase was much larger than economists expected, and suggests that China is printing as much as $2 billion worth of RMB per day in order to buy dollars to maintain the peg. The big problem is that China, with a booming economy, is adopting a monetary policy of an economy that is contracting. This is the perfect recipe for inflation.
And it's not just China that is enforcing a currency peg. Many other countries intervene in the forex market when they feel their currency has risen too high against the greenback.
For example, the Chilean currency gained 17% in value against the USD in just 7 months during 2010. The surging currency underscored the country's status as an emerging markets success story. But that condition abruptly ended last week when Chile's central bank pledged to intervene in the local currency market by increasing foreign currency reserves by $12 billion in 2011. After the announcement, the currency predictably dropped against the dollar and caused a major sell-off in Chilean equities.
The specious idea behind this action is that foreign governments believe that by keeping their currencies cheap they can bolster exports and maintain a strong economy. But a rising currency does not necessarily restrain exports. If those countries currently committed to pegs were to reverse course, their problems with local inflation could diminish. And those lower prices could offset to a certain degree the decreasing purchasing power experienced by the importers of those countries' domestic goods.
However many countries fail to understand this basic economic concept and fail to see the forest for the trees. By stubbornly clinging to the belief that a rising currency is bad for the economy, world economic leaders are helping to unleash a wave of inflation.
Typically, food prices are more volatile than prices for finished goods. It is there that this new wave of inflation is first manifested. Unfortunately, this means that the poorer people around the world, who pay a higher percentage of their income for food, will bear the brunt of the pain. A quick look at some alarming movements in food prices should give you a sense of how bad things are getting:
- Sugar was up 25% in 2010.
- Corn and wheat were up 53% and 49% respectively in 2010.
- Soybeans were up 28% in 2010.
- In December, the U.N.'s Food Price Index, which covers dairy products, meat, sugar, cereals and oilseeds, jumped an alarming 4.2% from the previous month. In so doing the Index passed the previous peak set in June 2008.
- India's food price inflation rose to a one-year high of more than 18% according to data released in early January. Rising food and energy prices in India have convinced many analysts that the Indian central bank will raise rates later this month.
- In China, food prices rose 11.7% from January to November 2010. In response, several cities have implemented direct controls to limit food price increases and the central government has vowed to eliminate speculation in the country's commodities markets.
Of course, global currency depreciation has also caused other commodity prices to rise. Food production is extremely energy intensive, and $90 per barrel oil has helped push food prices to new all-time highs.
The surging cost of fertilizer, driven in large part by U.S. ethanol policy, is also adding another driver to rising food costs. According to the EPA, ethanol sales in the United States are expected to rise to 13.9 billion gallons in 2011 from 12.95 billion gallons in 2010. The agency is requiring that renewable sources account for at least 8 percent of motor fuels sold in 2011. Congress is requiring that U.S. annual ethanol production increase to 36 billion gallons by 2022. With nearly 40 percent of the U.S. corn crop currently diverted to ethanol, the demand for fertilizer is likely to increase substantially.
Prices are already on the move. Mosaic, one of the country's largest fertilizer corporations, sold diammonium phosphate for $461 a metric ton in the fourth quarter, up 61 percent from a year earlier.
Admittedly, there are other non-inflationary factors that are boosting global food prices. For instance, poor weather conditions in major exporting countries across the globe have significantly curtailed harvests and expectations. And alongside bad weather in Australia, Europe, North America ,and Argentina, rising Asian demand is at the heart of the spike. China, for example, is expected to buy 60 percent of globally traded soybeans in 2011/12, which is double its percentage of four years ago.
But the genesis of soaring food costs lies at the feet of Ben Bernanke and his desire to re-ignite inflation domestically. However, countries like India and China have already started to reverse the inflationary effect of linking their currencies to the USD and are raising banks' reserve requirements and interest rates. Contrast those actions with those of our Fed chairman who has repeatedly stated that inflation in the U.S. is far too low. We can only hope Mr. Bernanke repents from his love affair with inflation before food riots land on U.S. soil.
In the meantime U.S. investors can help mitigate their exposure to rising food costs by perhaps looking to invest in those firms whose financial performance improves with rising food prices.