Global Macro Notes: Pondering the High Cost of Food
Next to guaranteed reelection, what is a politicians’ fondest wish? Perhaps benign economic conditions — the ability to enjoy upturned economic indicators, positive sentiment, and increased feelings of voter satisfaction all at the same time. “A chicken in every pot.”
When fortunes are tied to the ballot box, this is what Washington wants. And it is what the Federal Reserve (with the help of China) appears to have delivered, for the investing classes at any rate: Unrelenting paper prosperity, in which an overall “crisis contained” attitude seeds complacency along with profits.
In this world of levitating asset prices — never mind the possible correction brewing this week — what could derail the Fed’s “higher market mandate?” Is there any factor that could rudely intrude and kill the dream of perpetual paper gains?
Well, there’s the rising cost of food, for one thing. (Energy too.)
Let’s get rolling with two quotes, the first from Greenlight Capital’s year-end letter:
“On August 27, 2010, Federal Reserve Bank Chairman Ben Bernanke gave a speech in Jackson Hole, Wyoming where he hinted that the Fed would provide additional monetary easing. At the time, the S&P 500 was down more than 3% for the year. From that point through the end of the year, the S&P rallied 19%. At the same time, oil prices rose 16%, copper prices rose 32%, coffee prices rose 34%, corn prices rose 43% and cotton prices rose 57%.”
“In front of Congress, Mr. Bernanke credited his policies for “significant improvements in stock prices” which are “contributing to a better outlook for the economy.” Mr. Bernanke also said his policies are not to blame for the sharp increase in the price of oil, which he claims is the result of strong demand from emerging markets. Does Mr. Bernanke really believe anyone buys that? Ostensibly, it’s a coincidence that many of the necessities of life came into simultaneous shortage and shot up in price just as Mr. Bernanke promised additional monetary stimulus.”
And the second quote — while keeping the above in mind — is from our old friend Ludwig Von Mises:
“If once public opinion is convinced that the increase in the quantity of money will continue and never come to an end, and that consequently the prices of all commodities and services will not cease to rise, everybody becomes eager to buy as much as possible and to restrict his cash holding to a minimum size. For under these circumstances the regular costs incurred by holding cash are increased by the losses caused by the progressive fall in purchasing power. The advantages of holding cash must be paid for by sacrifices which are deemed unreasonably burdensome. This phenomenon was, in the great European inflations of the ‘twenties, called flight into real goods (Flucht in die Sachwerte) or crack-up boom (Katastrophenhausse).”
One could further consider the Von Mises observation in light of feedback loops, stores of value, and Gresham’s law (as we did some weeks ago). When paper money becomes “bad,” there is little incentive to hold it relative to stores of value that are “good” (such as farmland).
In Twelve Major Risks for 2011 we noted various possibilities of what could go wrong, one set of top down risks involving food inflation and civil unrest.
But for the purpose of these notes, the food and energy question remains unique as a top down risk because it is potentially an internal creation — an undesired yet unavoidable side effect, born directly of a Fed-sponsored and Fed-engineered scenario.
In sum, if we keep traipsing down the happy shiny non-withdrawn-stimulus path, we may reach a point where follow-on food and energy gains can no longer be civically tolerated from an end user standpoint. We note that this point would first be reached, and is in fact already being reached, in countries outside the United States.
To those who wave off such pressures, a modest sampling of headlines:
- World Moves Closer to Food Price Shock (Financial Times)
- Prices Soar on Crop Woes (WSJ)
- Record Food Prices Causing Africa Riots (Bloomberg)
- In Corrupt Global Food System, Farmland is New Gold (IPS)
- Surging Food Prices Sparking Riots Around World (BI)
- Iranians Adjust as Prices Soar (WSJ)
- India About to Hike Rates Again After Six Failed Efforts (BI)
- ‘Huge’ Chile Inflation Concerns Prompt Hike Predictions (Bloomberg)
- Brazil slams brakes to curb inflation (Telegraph)
- Rising food prices to drive rate hikes in China (beyondbrics)
China is clearly in the mix, with food costs at 40% of disposable income by various estimates. This is a real problem for a country with 20% of the global population, but only 6% of the farmable land (hat tip ZRH).
And speaking of China and grain costs, this brings up a tangentially related question. How can the dollar go to zero when America is the world’s leading grain exporter?
To clarify, we have never said that the dollar is a “zero,” though overzealous dollar bears have implied it (which is why we make a tongue in cheek reference here). Nor have we ever entertained the surprisingly popular idea that the U.S. can go full-on “bankrupt.”
As the grain equation shows, the reason the U.S. cannot go bankrupt is not just because technical default is impossible, though it is – the U.S. can pay off its debts with a printing press – but also because of the positive side of the U.S. balance sheet, which includes being a top grain exporter.
In other words, we’ve got the food. Your currency doesn’t go to zero when the world has to eat. The Saudi Arabia of grain has some clout.
And so if China one day said, “Hey – we’re going to sell all your bonds,” and Uncle Sam replied “Hey okay, we’re going to stop selling grain on world markets,” guess who would win that little game of chicken?
The U.S. would have a monetization mess to deal with — and an inflationary or even quasi-hyperinflationary currency episode — but Americans would still have food to eat.
Meanwhile the cost of grains on world markets would quadruple or quintuple in price (due to withdrawal of U.S. supply), leading to riots in Chinese streets and burning pitchforks in Beijing, as domestic food bills went from 40% to triple digits, consuming local incomes twice and thrice over.
Such a scenario would never play out, of course, any more than a full-blown nuclear exchange would. (But then anything’s possible right?) Hypothetical point being though: When you are the world’s bread basket, you have a fairly strong negotiating position as far as debt extremes go.
(This isn’t to say we are on the side of Keynesian free spenders who ignore the U.S. debt burden by the way. When it comes to the great debt debate we favor a hawkish stance, even though we recognize the technical truth behind the assertion that America “can’t go broke” and consider the more extreme dollar armageddon scenarios far fetched. We are fiscal hawks because America, though possessing unassailable balance sheet advantages at the core, can certainly damage its economy to further great and terrible degree, and invite destructive inflation in doing so, through needless piling on of more unproductive spending in Washington. And as for the austerity “threat,” politicians are great at giving lip service to austerity — a form of public pandering — but then spending like drunken sailors anyway.)
But back to the food problem…
It’s not just a global (i.e. non-U.S. domestic) issue, though it is very much that. Rising food costs, with unsustainable thresholds looming, are also a U.S. problem.
And that’s why we think viewpoints like the following are, well, either deluded or just plain nuts. Via Bloomberg:
U.S. investors should welcome, not fear, climbing commodity prices.
The increases are “largely a reflection of the fact that the pace of economic growth, particularly in the U.S., has picked up,” said Nariman Behravesh, chief economist at consultants IHS in Lexington, Massachusetts, and a former Federal Reserve official who has been covering the global economy for more than 35 years. “It’s not something to be worried about.”
As a former Federal Reserve official, one would guess Mr. Behravesh also agrees with Ben Bernanke’s 60 Minutes assertion that he is “100% sure” inflation can be contained. (Just like subprime was contained. Right Ben?)
“High commodity prices are the result of rising demand, not the cause of future economic weakness,” adds cheerful economist Michael Darda in the same piece. ““Over the last decade, commodity prices and the U.S. stock market have usually moved together.”
This is a remarkably head-in-the-sand view in our humble opinion — never mind the amusing fact that “the last decade” has been one long unbroken chain of central bank manipulation, with Alan “The Maestro” Greenspan seamlessly passing the money-pumping baton to Bail ‘Em Out Ben. Anyone who references “the last decade” as a reassuring stretch of monetary policy history perhaps needs their head examined.
Putting aside the poor non-first-worlders who spend close to half their incomes on foodstuffs, the supposed saving grace of the U.S. economy is that food and energy represent a much smaller portion of total incomes — so we can safely ignore their impact longer, as stagnating wages and chronic unemployment do a bang-up job of repressing “core” inflation statistics.
This little fudge allows the Fed to continue embracing its fiction that paper-stimulative policies that help the top 30% of households are helpful to the broad economy on the whole, even as those same cost-of-living inflating, middle-class-destroying policies make life an ever harder grind for the bottom 70% (who have no equity assets to speak of, still have to drive to work — assuming they have jobs – and are likely to buy generic cereal in bulk and generally throw nickels around like manhole covers).
Then too there is sector and industry fallout, as the Wall Street Journal notes:
Soaring global food prices, particularly for meat, sugar and coffee, are putting pressure on the restaurant, travel and hotel sectors as they pursue a fragile recovery. In a bid to offset added costs without passing them on to price-sensitive consumers, many companies are scrambling to renegotiate contracts, find cheaper suppliers and reconfigure menus.
Increased demand and market speculation, as well as bad weather like the recent flooding in Australia, have driven up prices for items ranging from coffee beans to beef. Prices of corn and soybeans, used as feed for cattle and chicken, have leapt over the past six months, pushing up meat prices. As a result, meat prices have also increased.
In the Mercenary portfolios and the Live Feed we have been happy to ride the long side of this unrelenting bull rally through areas like fertilizer, global infrastructure, solar, and global manufacturing.
But we have also been looking hard for areas in which to add short bias to our net exposure, and one place we have succeeded is in restaurants. The challenge of rising input costs has made the restaurant space one of the few areas of the market not levitated by speculative euphoria — and we will be adding more short exposure as price action further confirms.
(Side note: Merrill Lynch recently put out an industry-touting “buy the dips” report on restaurants, but we believe they are a day late and a dollar short — no pun intended, as Mother Merill tends to get clients “long and wrong” at highly inopportune times.)
Another factor working against the favor of restaurants – and broader retail at this point – is not just a steady rise in food costs but an increase in the price of fuel, another area of concern where the Fed Chairman absolves himself:
- Gasoline prices’ rise evokes 2008 (LA Times)
- Rising gasoline prices sour U.S. consumer mood (Reuters)
- Opec ministers say world can handle $100 oil (CNBC)
- Consumers face higher prices in 2011 (Marketwatch)
As the price of gasoline etc. hits consumers in the wallet and further increases transport costs, where are profit margins going to go? Where will reduced discretionary income flows go?
To zoom back out to a broader scope, the problem with the recent bout of quiet euphoria as we see it stems from a couple of offhand points:
- The long sweep of market history shows government manipulation ends in tears. You can’t manipulate your way to prosperity, and you can’t make false promises pay off through fancy accounting. You can make the paper manipulation game run for a long time, but ultimately it winds up going the way of all ponzi schemes. To the extent that Western governments (and artificial-growth-pumping Asian governments) deny the reality of excess leverage and the need for healthy adjustment periods in the business cycle, “kicking the can” is all they are doing.
- The “great reflation” posturing of the Federal Reserve and others has a built-in self-destruct mechanism. That built-in self-destruct mechanism is now revealing itself in the form of high and rising input costs (food and energy prices) as juxtaposed against stagnant, flat-to-down wages and sticky unemployment in the Western world, putting significant pressure on the middle and lower classes even as rigged government statistics deny cost of living pressures even exist. The bulls can conveniently look past this pressure and pretend it is somewhere between nonexistent and tolerable, up until the day it is no longer accepted as tolerable period — at which point everything cracks. The fact that countries like Algeria and Tunisia are ahead of us on the “cracking” curve is not of great comfort at this point.
- The Federal Reserve really has no clue what it is doing. They are just throwing Hail Mary passes willy nilly as the “grand Keynesian experiment” continues. QE2 was supposed to help the economy by keeping yields low. But yields went up, and QE2 was deemed a success anyway because equities went up. Forget any realistic attempt to translate temporary wealth effects or the impact of frenzied speculative froth to the underlying health of the real economy. Bernanke is a terrified academic fumbling in the dark without a flashlight.
- We are set to see increased pressure on consumer wallets, and economically in general, via rising tax burdens at state and local levels. State and local jurisdictions are raising taxes to fill gaping budget shortfalls. Municipalities will be forced to squeeze blood from a stone, and local consumers and small businesses are that stone. In foretaste of what’s to come, Illinois recently voted for “a giant tax increase.” Major battles with unions and public service workers are looming too as promised fund streams dry up. Again this comes from a backdrop of stagnating wages as multinational corporations squeeze out costs, not to mention long-term employment trends moving away from the U.S. and towards more profitable emerging market locales.
- The “Hail Mary” hope for central bank stimulus activity is that sustainable economic growth will kick in just in the nick of time, allowing the authorities to successfully outrun the heavy burdens of top down risk, accidental inflation and over extension of speculative credit, as such that they can deftly back away and extricate their artificial props with a sigh of relief as normal and newly robust economic conditions take hold. Unfortunately we feel this hope is about as realistic as Evil Knievel doing a motorcycle jump across the grand canyon, with similarly disastrous result when the manipulated euphoria wave finally fades and falls short.
In sum, watch food prices… keep an eye on commodities in general… and keep Katastrophenhausse in mind as a counterweight to the “Bernanke Put.” The Fed will be eating crow in the end.