Roenblog:

I have had enough!  I think that if I read one more misleading article on food inflation and its causes, I will puke in my trash can. Food inflation is becoming the dinner topic de jour for the concerned classes. Articles in the NYT and the WSJ point to decreasing supplies and rising prices of food, often blaming biofuels, and attacking farmers.  CNBC this week went as far as insinuating that farmers were reaping the benefits of starving people in developing countries. It’s time to talk about what is truly causing a rise food prices, and look at how much effect it is actually having. 

Americans only spend 9.9% of their disposable income on food according the USDA ERS. Since 1980, food spending as a percentage of disposable income is down 3%.  In 2008, the USDA forecasted that food prices will increase by 3 to 4.5% — roughly at the same pace as overall inflation. Given that apparel and housing prices are deflating (roughly by 4.5%), the overall effect to Americans’ bottom line is diminished.
The next question is: are we truly experiencing food inflation?  Below is a chart of wheat since 1980.  Looking at this graph it’s hard to dismiss the fact that food prices are rising.

But are we using the right metric?  The next chart shows the price of wheat after adjusting for inflation. 

But are we using the right metric?  The next chart shows the price of wheat after adjusting for inflation. 

That picture is a little different.  While prices have increased over the last two years, over the last 20 we are actually lower. The question still remains: are we using the right metric?  Perhaps the U.S. dollar is the problem.  Below is a chart of wheat quoted in gold. 
 

That picture is a little different.  While prices have increased over the last two years, over the last 20 we are actually lower. The question still remains: are we using the right metric?  Perhaps the U.S. dollar is the problem.  Below is a chart of wheat quoted in gold.  

Once again, we get a different picture.  In terms of gold, wheat is roughly the same price as it has been for the last 20 years. It is hard to argue that over the last two years we have not had food inflation, but I think there are good arguments that over the past 20 years the disposable income going towards food has decreased for Americans, and in inflation-adjusted terms food is still relatively cheap. 
So why are we experiencing food inflation?  Recently the CFTC held a forum to discuss speculators’ involvement in agricultural commodities.  End users of commodities are trying to blame their poor risk management on involvement of speculators in the commodity markets. Farm groups are trying to blame their margin calls on volatility created by speculators, and cotton trade groups are trying to say that speculators caused hedge efficacy to dissolve, forcing many to exit short hedge positions.  What many don’t understand is that commodities are a zero sum game.  What one pays in margin calls today, they will receive back in increased cash prices later.  Speculators provide a vital function in the market. 
Here are some of the top reasons food prices are rising:

1. Freight rates:  According to Bloomberg, the Baltic dry index has appreciated by over 500% in the last five years. This is rapidly increasing the cost of moving bulk commodities like wheat, sugar, and rice from production centers like Brazil and the United States to end consumers. The prices for rail shipments, barge and truck shipments have also increased.

2. Low prices:  U.S. farm policy for the last 20 years has attempted to encourage as much production as possible. The policy was to support a “base” price for small producers. The result of this policy is a fragmented farming industry populated with small producers who are less efficient that their larger counterparts.  Since farm programs only work for small and medium farmers, there was no incentive to consolidate the industry and increase efficiency. The policy kept small farmers producing, artificially increasing the supply of ag commodities. Since supply was high, prices were low. Low prices, and little prospect for higher prices in the future, limited investment in the sector. When prices and margins increased, the industry was not ready or able to respond to the increasing demand.
   

3. Government Policy:  Over the last year, we have seen numerous examples of governments attempting to limit domestic food inflation by increasing export tariffs or banning exports entirely. (Brazil, India, Indonesia, Kazakhstan, Ukraine, Argentina )This artificially increases the domestic supply but dramatically decreases the world supply. As a result, net importers are forced to chase smaller exportable supplies. This is the equivalent of what your article suggests on a global scale. By increasing stocks, prices rise. As evidence of this, I present the following table by the USDA Foreign Agricultural Service. World production of rice is increasing by 1.12% YOY. World demand is increasing by only 0.78%. This implies that world ending stocks for rice is increasing. I am not disputing there are areas of the world with supply problems, only that hording is causing stocks to be held in areas where they will not be used. 

4. Biofuels:  Roughly 5% of the worlds’ grains are being used to produce biofuels. No doubt that this is creating some upward pressure on food prices. The question is: Are biofuels having any effect on energy prices?  On the environment?  Are these benefits greater than the increasing food costs?

5. Acts of God:  Weather is one of the primary causes of decreased production. Two years of drought in Australia, combined with poor growing conditions in the U.S., reduced world production of global wheat supplies. While this may seem like a temporary situation, we can expect such “acts of God” to affect different agricultural producers across the globe every season and increase volatility in food prices.

6. Increasing world wealth and population:  As developing countries increase the wealth of the population, the first effect is more food demand, followed by more fiber and energy demand. Increasing wealth means more demand for protein. I have read several articles in the WSJ discussing sharp increases in China’s pork demand and ergo pork prices.

7. Increasing production costs:  Perhaps the most influential, increasing prices of inputs are increasing the costs of producing commodities. Rising natural gas prices are increasing fertilizer prices. Increasing oil prices are driving up diesel prices. If the price of farm products do not keep up with the rising costs of inputs, supply will be constrained.

All of these factors combine to create the illusion that food prices are increasing.
 

My former FFA project is officially out of control. Here are some pictures of spring calving at the Ryan Ranch. More than 20 babies are on the ground, with more on the way.