Saturday, January 8, 2011

Charting Bushels and Bernankes

As an amateur market observer, and certainly no economist, I have been reading all about the inflationary effects of central bank policies. One of the biggest concerns raised by many observers is the that of the impact of these inflationary monetary policies on food prices world wide. Seeing as to how the Fed and the PBoC are two of the most active of central planners, we're going to focus on them in this post.

Food prices have gone up dramatically in the second half of 2010. This coincided with Ben Bernanke embarking on QEII, of course. The UN Food and Agriculture Organization's (FAO) index of world food prices rose 32% during that same span.

It's important to note that the inflationary monetary policies have combined with bizarre weather to create the perfect storm. 2010 saw the uncontrollable fires raging in Russia that forced that country to place export bans on wheat, floods inundating Pakistan and wiping out large tracts of agricultural land there and, towards the end of the year, massive floods in Australia that threaten that country's significant agricultural output.

Fine, you might say, what about annual output vs. use? You know, the crops we grow and consume in a given year. Surely, we must grow enough to feed everybody? Not exactly.

Taking data from the USDA's latest World Agricultural Supply and Demand Estimates report, released in Dec. 2010 we find the following grim chart:

The above chart shows a disturbing trend. The global use of grains has grown by 3.9 % from 2008 - 2010, yet output has shrunk by 2.3 %!

Even more disturbing, is the fact that use exceeds output in 2010 by 56 million metric tons. So, where do we come up with that to feed everybody? Well we dip into our reserves of course and this is the result:

As you can see there's a significant 11.6%, projected, decrease in total world grain stocks (wheat, coarse grains and milled rice). Well what does that mean?

It means the entire world has enough grains for only 70 days at 2010 consumption rates.

The USDA also has a cost of production forecast, the latest being released in Nov. 2010. Taking data from there we come up with this chart:

Again, not pretty. It shows the operational cost ( Mainly: Seed, Fertilizer, Chemicals, Custom operations, Fuel, lube, and electricity) for an acre of total grain (Corn, Soybean, Wheat, Rice, Sorghum, Oats and Barley) going up by 9.2 % over the next 2 years!

Now, back to inflation. The FAO's 2009 Statistical Yearbook gives historical Food CPI. Taking this data we come up with the following chart:

As you can see, food inflation in China, from 2000-2007, has gone up by 33.5%! This is compared to 20.9% in the US over the same period.

This is confirmed by producer price data. The FAO has a nifty online tool that lets you browse, compare and combine food price data it has from all over the world.

In this chart, we can see the "Total Grain" ( Barley, Maize, Oats, Rice paddy, Rye, Sorghum, Wheat ) average producer price in US$/tonne from 2000-2008 for both China and the US. Both price trends show a steep upward trend beginning just after 9/11 and the bursting of the dotcom bubble, when the FED first began slashing interest rates. However, both virtually took off towards the end of 2007 when oil began its surge towards $ 147/barrel.

This warrants a closer look. Below we have a chart of the DBA (PowerShares DB Agriculture Fund) as compared to the USO (United States Oil Fund):

Now this is interesting. As the USO surged by 150%, peaking in July of 2008, the DBA jumped 70% in response. Notice, however, that while oil prices crashed during the great recession, food prices merely returned to their previous, pre-oil surge, pricing levels. This is indicative of strong demand/supply dynamics supporting those pricing levels.

The increase in food prices is felt differently in China than it is in the US. Some estimates indicate that Chinese people, on average, spend 50% of their income on food, as compared to only 13% in the US. That means that income growth has to keep pace with inflation, just to maintain these current spending ratios. Let's hope those Chinese GDP numbers are legit!

Finally, it's interesting to note that China is having a public debate about inflation and trying to tackle it head on. On January 3rd, 2011, the Xinhua news agency reported on a speech made by Chinese President Hu Jintao where he admits to the negative impact inflation is having on the populace.

An interesting snippet from the same Xinhua article:

Li Jianwei, with the State Council's think-tank, told Xinhua that the past several years saw surging prices, of which food price rises contributed the most growth.
"Our research indicates that the main reason behind the price hikes is the increasing costs," Li said. "These include rising labor costs, increasing agricultural raw materials and equipment expenditures, and higher transportation costs, which have been driven by fuel price hikes."
Admitting that price speculation played a role in boosting the prices of some specific agricultural products, such as garlic, ginger, and mung bean, as well as others, Li said this factor could only have a limited impact on the CPI.
Li added that the grain price rises that were mainly caused by increasing costs should be tolerated to an extent, but added that he expected the growth rate of grain prices for 2011 to be lower than 2010.
He said the pressure to drive prices higher in 2011 would come mainly from imported inflation, and the rising prices of imported raw materials, like fuel and ore, could boost industrial products' prices and thus, indirectly, affect agricultural materials' prices.

In conclusion, it's clear from the above data that China is suffering as result of pegging it's currency to the US Dollar. They can either allow it to appreciate and thus reduce the effects of inflation, or they can go into the market and bid up the price the of the US Dollar. Either way, as long as agricultural commodity transactions are settled worldwide in US Dollars, any talk of China dumping its US Dollar denominated reserves (mainly Treasuries) is unrealistic.

*Note: This post is based on publicly available data that is referenced throughout. This post is not intended to be investment advice nor should it be taken as such. The author is not responsible nor liable for any investment decisions taken as a result of reading this post.


Kalpa said...

Nice blog and interesting post. Keep up the good work

Fedup Montrealer said...

Thank you for taking the time to read and thank you for the kind words!