Friday, April 18, 2008

Food: Scarcity or Bubble?

Since climate change and financial meltdown aren’t enough for us, we’ve been handed a third crisis, the explosion in global food prices. Hunger is now, famine looms in the future.

There are two broad views of the problem, epitomized by two of this morning’s readings. Marc Lacey, reporting in the New York Times, tells us that poor Haitians are eating mud, the final link in a chain that begins with rising demand from China and other expanding economies, declining output due to drought and disease and the diversion of cropland to biofuel production. Meanwhile James Hamilton, over at Econbrowser, shows that a basket of commodities, including not only basic foods but also minerals and oil, has been rising more or less in tandem, suggesting that a financial mechanism is at work. Who is right?

Let’s take the mainstream view first. There are three proposed factors, one on the supply side and two that show up on both demand and supply.

Let’s start with supply. It continues to rise overall at the rate of about 2.5% per annum, although there are much publicized crop failures in rice. At least in the case of Australia, the collapse of rice production is the result of drought, presumably attributable to early effects of climate change. Even though this is not a principle cause of the current global crisis, if Schlenker and Roberts are right, we should be very worried about the future. (I should add that my own view, based on long run considerations concerning pest and pathogen evolution, soil quality and water mining, is that industrialized agriculture is still an unproven experiment.)

The uptick in demand is seen as resulting from economic growth and competition between food and biofuels, although both may also show up in reduced supply numbers. The first of these can be described as the conversion of hundreds of millions of formerly poor people, in China, India and parts of Latin America, into middle-class food consumers. Hamilton dumps on this, saying (of commodities in general):

I also find it implausible to attribute the commodity price increase to a surge in demand. The economic news over the last three months has been very convincing that output is slowing, not accelerating.

He may be right about other commodities, but, in the case of food, the issue is the shift from direct grain consumption to meat, which has the potential to increase total demand far more than simply piling a little more on the plate. There are important threshold effects at work, so simple linear relationships between aggregate income and meat consumption will not necessarily capture the dynamic. While George Monbiot places great stress on diet, and rightly so, it is also the case, according to the FAO, that use of grains for animal feed is not rising faster than supply. Diversion of land for pasture would be another factor to consider, but it would show up on the supply side.

Competition with biofuels is just beginning and currently has a small effect on global demand, less than 5% of total output based on direct use but not diversion away from cereal production (as in Brazilian cane), which impacts supply. Biofuels are growing very rapidly, however, and may be significant at the margin, since, with inelastic demand in the short run, small shortages can give rise to large price spikes.

Now consider Hamilton’s case, which parallels Jeffrey Frankel. It rests on the following diagram, for which I am very grateful.

If all storable commodities have trended upward, we should look for a common cause and not get bogged down in the individual factors affecting each (which may nevertheless tell us why some are surging faster than others). His candidate: all of them are attractive stores of value in a world in which short term interest rates, in the US at least, have turned negative. This is plausible, although I would add that this argument should be examined in dynamic terms. At any point in time, a movement of real interest rates deeper into negative territory should result in a one-time increase in commodity prices. (This underlies Hamilton’s suggestion that the Fed confound the markets and refuse further cuts in the fed funds rate, which would permit a real-time experiment.) But a continuing trend toward higher commodity prices implies either a continual process of asset switching or a continual increase in funds chasing assets or both. The first, according to Hamilton’s logic, would arise if interest rates were falling over time. The second, which interests me, implies that some of the funds that have previously inflated bubbles in mortgage-backed and other dollar-denominated securities are now finding their way into commodities. I repeat: the sovereign recycling of dollars on the capital account has to find assets, and, since the flows are not based on profit expectations, they will push the prices of the assets they end up in beyond their reasonable fundamentals. (Yes, profit expectations can also be wrong, but sovereign recycling doesn’t even try to be right.) If this is happening with food it is a very, very big deal.

So where are we at? As always, we need more data. The asset-switching hypothesis really does need to be tested, pronto. The biofuel diversion is politically driven and can be stopped in its tracks if Washington and Brussels will it. In fact, I am worried that, as fuel prices increase in the years to come, simply ending biofuel mandates and subsidies will not be enough; we will need to install roadblocks. George Monbiot is right: we should eat less meat and be willing to pay more for it, as meat is shifted to marginal cropland and small niches in the farm production system. Above all, subsistence in a resource-scarce world will always be a problem when global income is distributed so unequally: the Gini coefficient for global income distribution is about .65, higher than in any single country, as Milanovic has shown. The spread of hunger in a world with so much wealth should tell us, in a blunt way, that we have a social justice problem.

In the very short run, the rich of the world should pony up and help feed the poor.


ProGrowthLiberal said...

Dr. Hamilton's evidence is that the increase in the relative price of food has not quite kept up with the relative price of oil? That's not exactly reassuring to poor people who consume oil based products to get to work and then have to have their low wages be stretched over rising prices of food. OK - their may be a financial mechanism as PART of the story for both.

Krugman's graph showing the jump in the nominal PPI for food (US index) during the Nixon years - which was noted by the NYTimes - motivated me to plot this series relative to overall PPI as at least a crude means over looking at the relative prices. Graph over at Angrbyear. My attempt at this suggested relative prices have been more noisey than exceptioanlly high. Of course, it was a crude measure to be sure. So if it comes off at being Pollyanna-ish, that wasn't my intent.

Bruce Webb said...

The rate of change suggests that the effect is largely financial. It is simply not the case that 2 billion Chinese were subsisting on a handful of rice or a bowl of noodles two years ago when corn was sitting at $2/bushel and are not all eating corn-fed porterhouse steaks. I don't see how relatively slow qualitative changes in diet and overall lifestyle (more cars etc) in India and China propagate with the kind of speed needed to make the quantitative changes we are seeing today.

My sort of underinformed opinion is that some crimps on the supply side (crop failure in Australia, diversion of corn to ethanol) translated to cramps on the demand side (notably hoarding). We are living in a country where two years ago we were actively paying farmers not to grow food. I find it difficult to believe that the fundamentals of a worldwide supply/demand ratio really could turn on a dime in the way that recent commodity prices suggest.

I remember the oil embargo and the subsequent rationing system and the absurdly long lines at the gas station. But a lot of those people were simply topping off their tanks, whereas in normal times they would run their tanks down close to Empty people panicked when the needle pointed to anything below 3/4. Because who knows? Which led to hundreds of millions of gallons of gas riding around in cars that normally would have been in the tanks at the service station.

When you see a country like Thailand, which has not to my knowledge had crop failures, and is a very large net exporter of rice impose purchase limits on domestic rice sales it is hard to see this as a real change in real demand (rice to fill stomachs) as opposed to financial demand (rice to fill cupboards).

(But who knows, I have similar views on housing, views that are not shared by hardly anyone.)

jaundist said...

In the great scheme of things in the world, people are in fact starving. One has to wonder whether, in spite of all the quant rhetoric, there will be a voice which responds as forcefully as Harry Hopkins in the ‘30's , e.g.,- " Hopkins and the Brain Trust were criticized for excessive spending by conservative members of Congress, who claimed that the economy would sort itself out in the long run. To which Hopkins replied, "People don't eat in the long run, they eat every day."

Bruce Webb said...

Juandist of course you are right as rain.

Which still leaves the fundamental question whether the issues are fundamentally those of production or distribution and then breaking down distribution between issues of fuel/food and meat/grain. There is a lot of people running around shouting 'corn based ethanol!!' and 'Chinese people eating beef' and little of people really looking at issues of storage and hoarding.

The stories of people in Haiti eating mud are horrible, but the stories of food rotting away by the ton in the Haitian ports are truly horrific. It is far from obvious that the opening of an ethanol plant in Kansas last year immediately translates to hunger in sub-saharan Africa, when you are dealing with commodities the actual distribution channels don't work frictionlessly, congestion is just as important as route. It is probably true that you could simplify this to the point of 'Too little food, too many western cars' and not be too far from the fundamentals, but you wouldn't be any closer to a sensible policy conclusion.

reason said...

I don't see how the argument of parallel movements, necessarily implies a financial cause, at least not for those products that are substitutes for one another.

Bruce Webb,
I am sympathetic with the idea that some hoarding will accompany a sudden increase in price. But I think the common factor is a run DOWN in stocks. Stocks have fallen to a level where small shocks can have substantial effects on price.

ProGrowthLiberal said...

Krugman weighs in on the bubble explanation - noting it would imply a lot more inventories than we see now.

Myrtle Blackwood said...

"At least in the case of Australia, the collapse of rice production is the result of drought, presumably attributable to early effects of climate change. . ."

Certainly there's been climate change in the Australian rice-growing regions. There has been unsustainable water-mining to grow those crops as well. Then throw in the proliferation of industrial monoculture tree plantations in the wheat and rice growing areas. Whilst these monstrosities don't take up a large percentage of the food growing land (as distinct from this disaster in Australia) the tree crops do take up a disproportionate percentage of the available water.

Brenda Rosser
[Checking in from Gunning in New South Wales with a very intermittent internet connection.]

Myrtle Blackwood said...

"(as distinct from this disaster in Australia) . ."

:(as distinct from this disaster in Tasmania}