Wednesday, February 27, 2008

From food fights to food wars

You thought your morning latte was irreverently expensive? Well, I have bad news for you. Do not be surprised if you see the price of your favorite Starbucks beverage going up even more in the not-so-distant future. Whether you’re the rich, sweet and creamy kind or just plain, bold and bitter, the spicy, “extra-everything” type or just a placid tazo-tea variety, rest assured, there will be hikes for all.

The reason? “Soft commodities” (“food”, in loose English) are going bizerk. Whether it’s coffee, cocoa, milk or sugar—all quintessential ingredients for your mocha frappuccino—a chart of their prices since late last year looks like the ultimate bliss for an avid rock-climber. Mind you, at stake is not just your frappuccino. Basic staples like wheat, corn, rice and soybeans have skyrocketed, threatening the livelihood of millions of poor around the world. What’s going on?

Emerging needs: First it was oil. Then metals. Now food. Let’s face it, consumption is contagious. And with demographic giants like China, India and Russia seeing rapid and uninterrupted economic growth in recent years, their emerging middle classes have begun to demand not just better roads and bridges but more cars, cellphones and, yes, food.

Take coffee for example. Imports of coffee by the ”emerging economies” rose almost 90 percent between 1995 and 2005, compared to a more “modest” 32 percent in the advanced economies. Sure, the much lower starting levels in the emerging world mean that even a 90 percent growth may not be that breathtaking in terms of actual bags of coffee. But just think what will happen when 1.3 billion Chinese learn how to say “calamel macchiato!”

Guns, strikes and the “battle for acreage”: Then you have supply shortages, of both the sporadic and the structural variety. The former include anything that may disrupt production temporarily, from labor strikes in the Ivory Coast (the world’s largest cocoa producer) to quasi ethnic cleansing in Kenya (a major coffee exporter). The latter are of a more permanent nature and include confined agricultural land; competition for land between agricultural and ethanol producers as high fuel prices continue to make ethanol viable; more frequent floods and other natural disasters, affecting negatively crop yields; or regulations that may discourage investment to make production more efficient.

Coffee or wine? Then you have the speculators. When markets are tight—e.g. limited land in face with growing demand—investors are encouraged to “speculate” that the only way for commodity prices is up, which pushes prices even higher. Indeed, to facilitate making bets on commodities, many investment firms have constructed commodity-linked indices (which track the prices of, say, wheat, sugar and soybeans or composites thereof) with names at least as complicated as a Starbucks drink (such as Barclays’ “Commodities Outperformance Roll Adjusted Liquid Strategy Index”!)

Importantly, investment in commodities has been seen recently as a hedge against unanticipated inflation. Existing investment instruments that help protect your savings from inflation (such as inflation-indexed bonds) do not offer protection against unexpected increases in inflation (quite naturally, since they are unexpected!). So if these unexpected price increases turn out to be persistent, the purchasing power of your savings is eroded.

However, some investors saw that investment in commodities did offer protection—most likely because a hefty part of the unexpected inflation in recent years has come from sharp increases in the prices of commodities themselves (food, energy and metals). So had you kept a few bags of Arabica in your cellar, a few ounces of gold and a few dozens of barrels of crude, you would have been more than protected against the higher inflation that we’ve seen recently. Alternatively, you could have invested in a commodity-linked index and kept that cellar for some fine red wine!

Food war victims: So how long can commodity prices stay at towering levels before we all engage in food fights (sorry, food wars)? While the (US-led) global economic slowdown may put a temporary brakes on prices, the tight market conditions are likely to keep them at elevated levels. Meanwhile, various corners of the world are facing nightmares.

The poor first and foremost. Sure, with prices that high, at least some poor are getting a windfall, namely those in major commodity-exporting countries. To come back to those lattes, coffee producers in Brazil have seen their prices rise 20 percent annually over the past five years. In less “affluent” Ethiopia—the birthplace of coffee—producers saw their prices rise 13 percent annually. That’s arguably a decent pay rise, at least in relative terms.

But one might also want to consider the hundreds of millions of poor who happen to be on the importing side of the story; those who have seen the price of their daily naan climb while living in the same abysmal conditions and with the same miserable, subsistence salaries. The situation is increasingly severe, given that the share of food in a poor household’s total expenditures can be as high as 70 percent—much higher than the 13 percent spent by Americans.

Back home, the combo of lower growth and higher inflation is causing Ben serious headaches. That’s Fed Chairman Ben Bernanke, whose job is to steer the economy towards doing quite the opposite: Higher growth and lower inflation. To the extent that persistence in food inflation might lead you to revise your expectations of future inflation upwards, Ben will have a much harder time cutting rates further to bring the economy out of R_____!

So, actually, we might all be better off if you forget about what you just read, enjoy your cran-apple crumb scone and dream blissfully that next year it can only get cheaper.

Glossary: soft commodities, emerging markets, tight markets, inflation-indexed bonds, naan, reduced-fat pumpkin chocolate chip coffee cake.

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Anonymous said...

Mots of good points, but one criticism, which is amplified by the citation of the euro reaching new highs. As commodities are priced in dollars, citing a rise in percentage of something priced in dollars tells only half the story, since the dollar is rapidly depreciating worldwide. I know you are based in the US, but for people based in Europe or elsewhere, if their currency is going up 20% a year versus the dollar, and a commodity priced in dollars gors up 15%, that commodity ios now cheaper. You see this with oil for instance - whereas prices per gallon are soaring in the US, they are remaining relatively stable in euros, because the same euros now buy more dollars... perhaps this is something for another column, but thought I would bring it up!

Chevelle said...

Point very well taken. I admit it’s tough living in this country without being afflicted by an overpowering sense that it's the centre of the world! But just to prove (to myself above all) that I am not too US-centric, here are some numbers:

True, if you’re Brazilian, you have seen your currency appreciate by around 60 percent vs. the dollar since early 2005. If you’re Philippino, Czech, Pole or Slovak, you have seen appreciations of the order of 30-40 percent. In more advanced economies, the appreciation has been less staggering though still impressive: Around 20 percent for Canadians and Australians, and 13 percent for Euro-landers.

How do these compare with commodity price increases (in dollars) during the same period? Let’s see… 74% for oil; 160% for corn; 165% for soybean; 130% for barley; 210% for wheat! Ouch!