Fisher Investments Editorial Staff
Geopolitics, Inflation, Monetary Policy, Media Hype/Myths

Distribution or Inflation?

By, 02/04/2011

Story Highlights:

  • Rising food costs aren't closely tied to increasing money supply or velocity.
  • Distribution is a primary price pressure on food prices—impacting the supply side of the equation.
  • Higher food prices likely aren't a catalyst for radically tighter monetary policy globally.

The United Nations announced Thursday that food prices are at record highs, and (in no small coincidence) recent violence in Tunisia, Egypt, and Jordan (to a lesser extent) is being blamed on these same high food prices. Two questions have arisen from these related issues: First, just where is all the food? And second, won't higher food prices cause inflation and lead to central bank tightening that could squelch recovery?

Though some areas are experiencing shortages, there is no global lack of food. Thanks to incredible technological advancements and massive productivity gains over the last few decades, the world can more than feed itself. Of course this has been the case for decades, but a lack of effective distribution has allowed hunger to remain. For this reason, improvements in transportation infrastructure and distribution typically do more to lower food prices than any other single response.

Food distribution is a long-term issue. In the short term, drought, flood, or geopolitical tensions can pressure prices. But many types of food are fungible—or at least there are easy replacements (e.g., if corn runs short, you can eat rice). So the impact from such disruptions may lead to higher prices or a reduction in quality—but these are usually temporary and local, not long-lasting and global. Demand-side factors, like government subsidies (e.g., corn-based ethanol in the US) and increased meat consumption by Emerging Markets' developing middle class, can also play a role in higher prices.

However, it is important to remember that demand is relatively self regulating, with consumers only continuing to demand more if it raises their standard of living or allows a positive return on their investment. This growing demand from increased bio-fuel usage and the development of the middle class in the Emerging Markets, combined with bad weather in some major regions, has pushed food prices right back up to the highs of the last bull market.

Though distribution is better now than it was in decades past (thanks to better infrastructure), poor countries with authoritative regimes (as we're currently seeing in Egypt and Tunisia) that are not participating in the global economic boom are hit hardest by recent food inflation, since incomes there aren't rising at a corresponding rate. Thus, the populations are rioting for greater economic freedom. Freer nations rarely see such issues. And richer (but still not-so-free) nations, like many oil producers in the Middle East, can simply buy their way out.

But what about inflation leading to central bank tightening? Quick and temporary moves in food prices are common. The consumer price index (CPI) and other widely used inflation indexes publish a "core" metric, stripping out volatile categories like food and oil because they are prone to sharp swings. But the pressures impacting food prices most (e.g., poor distribution, weather patterns, and government subsidies) aren't directly impacted by monetary policy. And because rising food costs aren't closely tied to increasing money supply or velocity, central banking actions like raising rates aren't typically an effective tool in combating rising food prices. That point was well stated Thursday in European Central Bank President Jean-Claude Trichet's comments that inflation pressures tied to food and commodities in the eurozone were short term in nature and medium- to long-term inflation pressures (their target) are modest. 

If governments want fewer volatile food price swings, they would do well to quit monkeying with distribution. Meanwhile, rising inflation is a risk, thanks to central banks' very accommodative stance over the past several years. But capacity still isn't at previous peaks, and unemployment globally remains relatively high—meaning producers can't start moving prices much. When that higher inflation comes, how central banks deal with it remains to be seen. But higher food prices likely aren't a catalyst for radically tighter monetary policy globally.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.


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