Food Inflation is a Problem the Reserve Bank of Australia Can’t Fix

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“There is nothing either good or bad, but thinking makes it so,” Hamlet tells Rosencrantz and Guildenstern in act two.

Poor Hamlet. He was so confused. A fist to the face does not become a ticklish feather merely because you think it so.

But he did have a point about perception. Two investors can look at the same objective fact, and because we human beings perceive the world subjectively, through our own experiences and prejudices, reach opposite conclusions.

Take yesterday. The Reserve Bank of Australia made public the notes from its February 5th meeting in Sydney. Though the report was full of hawkish language about inflation and the need to reduce strong domestic demand, investors chose to focus on the “strong economy” language and not the “higher inflation” language. So Aussie stocks rallied.

Inflation is bad. Thinking otherwise doesn’t make it so. The meeting notes recognized the trouble in global financial markets but added that, “the main risk was that demand would still prove to be too strong to allow a decline in inflation over a reasonable time period.” Board members, “therefore concluded that the outlook for inflation required an immediate response from monetary policy. The debate focused on whether the change in the cash rate should be 25 or 50 basis points.”

As you know, the Reserve Bank settled for a 25 point rise, with another March rise a near certainty. It might curb the borrowing and spending habits of Aussies. But when it comes to food inflation and fuel inflation, there’s not much the Reserve Bank can do about that, is there?

Crude oil closed up nearly 5% in New York trading to once again cross the $100 barrier. Oil is up 9% on the year and 72% from the same time last year. The nominal high is still short of the inflation-adjusted high in 1980. Oil hit $38 in 1980, which in today’s ever-more-worthless U.S. dollars, is about $103.

Still, oil’s run has caught us a bit off guard. We’re long-term energy bulls. But we reckoned that slower global growth this year would curb crude demand and bring prices down to the low $80s. We even thought speculators might cash in some chips and reduce the investment demand for oil in the futures markets, bringing the price down more.

We’re wrong about that so far. Another oil refinery, this one in Big Spring, Texas, has suffered an explosion. These refineries have been running flat out for years, with virtually no down-time for repairs. It’s bound to happen. And you also have continued geopolitical instability in Nigeria, that moron Chavez in Venezuela, and OPEC threatening production cuts. Concerns about supply have trumped prospects of global growth.

Gold was up $23 and trades at $930.10 on the NYMEX, according to Bloomberg. Platinum hit a new high too at $2,174. And wheat? It’s set a new record high 16 times since September. “The biggest rally in the history of wheat trading defied even some of the best conventional wisdom, humbling forecasters Goldman Sachs Group Inc. and the U.S. government,” reports Tony Dreibus at Bloomberg.

We mentioned it yesterday, but something strange is going on the agricultural markets. Food inflation is here and prices are soaring. It’s partly cyclical. It’s also partly monetary, as all dollar-denominated commodities react to a weaker U.S. dollar. But there’s more to it.

What moves like its 1974

The chart above from my friends at TheChartStore.com shows spot wheat prices (per bushel) since 1860. As you can see, wheat prices traded in a range for nearly seventy years between 1860 and 1917. Industrialization and improvements in agriculture infrastructure led to higher crop yields. But World War Two put food production (and security) back on uncertain footing (even leading to the Bengal famine in 1943, where some 1 million people starved).

India became independent from Britain in 1947. And the postwar era combined with the Green Revolution in agriculture has led to steadily declining wheat prices. The exception was in 1974, when wheat, like all other dollar-denominated commodities, reacted to the decoupling of the U.S. dollar from gold and the whole world enjoyed a bear market in stocks and inflation (stagflation).

Yet the evidence shows that up until recently, the price of raw materials (including food) has been going down. Could it really be different today? Are we witnessing some sort of super cyclical tipping point in flood inflation where prices will get more expensive and not less expensive? Or is this just another inflationary cycle, the kind that comes and goes?

A clue to the answer lies in the chart below. True, central banks today are inflating as they were in 1974. But there are also about three billion more people on the planet today than there were the last time soft commodities reacted to dollar weakness.

If you looked at the first chart, you’d think wheat would be due for a correction, having basically matched its 1974, monetarily-motivated move. But will the move be bigger 34 years later because the world is a bigger, hungrier place today?

The Reserve Bank certainly can’t do much about food inflation driven by population growth. China reported that inflation ran at 7.1% in January. Jane Macartney reports for the Times of London from Beijing, “Inflation is starting to hurt ordinary people in a country where tens of millions live in poverty and as much of 50 per cent of household income is spent on groceries. Food, which makes up one third of China’s consumer basket, cost 18.2 per cent more in January than a year earlier, after rising 16.7 per cent in the year to December. Many Chinese say that now they try to avoid pork because the price of the staple meat for the country’s 1.3 billion people has soared 58.8 per cent from January last year.”

The upside for Australian investors?

What production of 13.1 million metric tons was up 23% from last year, but is still down 39% from the five-year average. Still, if farm exports start to catch up with mineral exports, look for even more improvement in Australia’s terms of trade. Al’s got the whole story covered over at Money Morning and in Diggers and Drillers.

Dan Denning
The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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7 Comments on "Food Inflation is a Problem the Reserve Bank of Australia Can’t Fix"

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beyondtool
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“The Reserve Bank certainly can’t do much about food inflation driven by population growth.” Thats the problem in a nutshell. The Australian Government and the Reserve bank have been asleep at the wheel. We are entering into the age of food wars, there are too many mouths to feed and not enough food for the global population. Grain reserves are falling. The green revolution has left much farmland poisoned and unsuitable for crops. Global warming is beginning to impact the food and energy supply. These are more than just economic problems, but stem from the reliance on a system that… Read more »
robroy
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Re-Read the press from the pink professors from the 60’s & 70’s on the great famines to come in the 1990’s. See what “helpfull” white men did to low caste women in India and what the chinese keep doing today to their Han. Selling this crap is easy but it is time to own up to your individual responsibility for what horrors are pushed downstream. There is a place in our heads dominated by the wilful thug needing to appease the reality of our limited place in the world. The Al Gore version of global warming is just more of… Read more »
mike
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…why not lower the interest rates for australian food producers who sell into the domestic market….while keeping the interest rates for producers selling to offshore consumers competitive…..

mike
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..why not vote every four years for which commercial bank will function as the nations central bank…..

James Bond
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I know how we can fix the global inflation problem thats emerging at present. The problem hasn’t emerged because of the demand and supply relationship in my opinion. The increases in demand for all commodities could of easily been foreseen by the people that have arranged and designed the international commercial system. At the same time that international demand increased from their globalisation they also manipulated the supply side (created conflicts in Middle East, diverting food corn production to ethanol through tax incentives, etc). The price of the commodities is totally managed by the international banking cartel (Goldman, Lehman, Deutsch… Read more »
John
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James, Sure they can influence the price of gold (and surely do), but they don’t have unlimited resources. Eventually they have to cave in to the market pressures or they run out of gold. Remember, they have to sell gold in order to drive the price down, not buy it. Once they’re out of gold, they have no more means to lower its price (only to raise it, but that’s something that happens anyway). I really believe the world markets will soon turn to gold as a global currency (some kind of an electronic system probably, but backed by real… Read more »
James Bond
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James They don’t have to cave in to any market pressures. Remember that they are the market, they are the MARKET MAKERS. It is not possible to outdo this clique in terms of price pressures. They have all the capital they ever need to control the price and oppose any price pressures which may emerge. They have at their command virtually the entirety of the capital at offshore banking centres and don’t forget that they also are the banks which deal directly with the central banks and the rest. Nothing can compete with that. What is some poxy ETF gonna… Read more »
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