Nuns mug orphan!

Soon we'll all be fighting for food!

NUNS mug disabled orphan for bag of crisps. As a headline, it certainly grabs the attention. This is the title of the latest note from the iconoclastic fund managers at Bedlam Asset Management, and it relates to a phenomenon that is sweeping the world—rising food prices.

Merrill Lynch has also coined an eye-catching term for the process: agflation. The prices of rice, wheat, corn, barley, cattle and pork are all up by more than 30% since March 2005. In America, the annual rise in the producer-price index for finished consumer foods has picked up from a little over 1.5% last year to almost 4%. Food prices are rising faster, relative to other measures of core producer-price inflation, than at any time since the early 1980s.

It is not too difficult to work out what is going on. At one level, the rising prosperity of India and China is ensuring higher demand. In the normal course of things, this would not be a problem. Unlike producers of other commodities, such as oil and lead, which take years to bring to market, farmers should easily be able to respond to higher prices by increasing output, particularly by bringing marginal land back into cultivation.

Some of this has been happening. Reports of increased corn plantings have pushed corn prices down so far this year, but wheat is substantially more expensive. Even so, markets may not be as responsive as they used to be.

The primary reason is climate change. The Australian drought is a clear case of unusual weather conditions having a direct impact on food production. But the indirect effects are probably more important, as land used for food production is diverted into use for ethanol, to provide an alternative to gasoline. In turn, land used to produce soybeans is diverted to higher-priced corn (until recently, this was forcing up soybean prices). And as animal feed grows more expensive, so do the prices of beef, pork and chicken. Tyson Foods, an American agri-giant, said that higher feed costs led to a 41% drop in poultry profits in the first quarter; the company will try to pass on those costs (processed chicken prices are up nearly 30% year-on-year).

As Bedlam points out, government interference in the system does not help. American consumers would be better off if Brazilian sugar, rather than Midwestern corn, were used to produce ethanol; high tariffs make that difficult. Across the Atlantic, grants from the European Union are designed to reduce the area of land under cultivation.

Higher food prices also cause a problem for central banks. Agricultural products are usually excluded from “core” measures of inflation, on the grounds of their volatility. But if there is a long-term secular rise in food prices, as Bedlam suggests, such an exclusion may be short-sighted. At the very least, higher food prices (rather like oil) will reduce the ability of consumers to spend money on other goods. Other things being equal, higher food prices should cause a poorer trade-off between headline inflation and growth.

Agflation may also cause political problems around the globe. According to Bedlam, food accounts for 33% of China’s consumer-price index and 45% of India’s. Perhaps we are unlikely to see nuns stealing food. But we could see governments fall—bread riots are one of history’s most recurring phenomena. And governments may start scrapping with each other over natural resources. That can lead to geopolitical tensions, and greater risk across all securities markets.

To sum it all up, we could very well find ourselves in a situation where we are “damned if we do, and damned if we don’t”. For that reason, we urge you to take the inflation risk seriously. Based on the evidence of recent market behaviour, though, equity investors are clearly not worried about these developments.


link

http://www.moneyweek.com/news-and-charts/economics/why-its-time-to-take-the-inflation-threat-seriously.aspx