An interesting article found on the Huffington Post website, originally published by Reuters, suggests that this year’s higher food prices are here to stay. (Click here for article). We don’t necessarily disagree with the article, but we do question some of their analysis.
First, there is a quote from a Chicago based commodities trader that says “Everything is set to the point where supply equals demand right now.” This seems to imply that at some point in the past, or there will be a time in the future when supply does not equal demand. Markets tend to adjust quickly to shortages and surpluses. This is especially true of actively traded markets such as the commodity markets. A surplus occurs when the amount supplied in the market exceeds the amount demanded. Markets react by reducing prices. When demand in the market exceeds supply, a shortage occurs and prices rise. Thus, the adjustment of prices always creates a situation where supply equals demand.
Extreme weather, droughts, and floods certainly have an effect on the supply of food and any of these events causes food prices to rise. Likewise an increase in fuel costs also reduces food supplies and raises prices. Also, as of January 1, 2011 all new tractors must meet Tier 4 emission standards which increases the price of these capital items. (Reported on Farms.com)
On the demand side, there are a couple of things to note. The demand for ethanol is high because the US government uses policy to support corn farmers. As anyone that has consumed liquor knows, ethanol can be produced from almost any crop: corn, rye, barley, sugar cane, rice, grapes, blueberries, elderberries, cactus, potatoes … the list goes on. Also on the demand side, governments keep stores of foodstuffs to protect against supply shocks. When crops are good, governments buy food and store it. When crop yields are low, governments can mitigate price rises by depleting inventories. In the year(s) after a poor harvest, governments replenish their reserves, temporarily increasing demand. This is not permanent.
China has a different problem. Their official policy of undervaluing the yuan makes their exports cheaper, but it also increases the price of their imports. India, and the remaining BRIC countries (Russia and Brazil) have been attempting to slow the appreciation of their currencies as money moves away from Europe and the US. This also causes import prices to rise.
Most food crops are seasonal in nature and producers can change output in a year or less. If food prices are expected to stay high, watch for an increase in the number of farmers producing the more expensive crops and reducing the production of the lesser expensive crops.
This is the ‘invisible hand’ that Adam Smith referred to and it is the way that markets work.
Somalia is currently experiencing a svere drought as a result of several seasons of reduced or zero rainfall. A recent report suggested that the prices of some food staples had risen by 80%, largely because merchants were hoarding food supplies in anticipation of even greaterSomalia is currently experiencing severe drought profits if the drought becomes catastrophic (as seems likely). Human greed is yet another factor in the equation.
ReplyDelete