Credit Crunch, food prices and inflation.

This week has seen more moves to ease the Credit Crunch in the USA. The Fed has taken the drought in the money markets seriously, and has kept a big flow of liquidity available to ease the worst of the problem. The Term Auction facility is now up by another $50 billion to $150 billion. There are $100 billion of 28 day repurchase agreements, and $62 billion of reciprocal currency facilities with other Central Banks. There are some signs that rates in US money markets are falling from the extreme differentials of the worst of the Credit Crunch as a result of all this extra liquidity.

Now the jeremiahs are worrying that this will be bad for inflation, forcing higher interest rates ere long when the Fed realises the evil of its ways.

The latest figures for the US economy do not illustrate an inflationary problem. Over the year ended 31 March 2008 US productivity grew by a satisfactory 3.2%. Because people across the economy were working 3% smarter, with modest wage and salary rises overall, costs were under good control. Unit labour costs only grew by 0.2% for the year, hardly evidence of an incipient inflationary lift off.

The price increases are all coming from the price of food, energy and raw materials, which have been rising dramatically worldwide over the last six months. The surge in food prices is most alarming, as it is pricing the poorest out of their basic diets. The big rise in oil and other energy prices has a knock on effect to all prices of goods that need energy to produce them and energy to transport them.

The flooding of rice lands in Asia, the impact of the severe winter in China on agriculture and the demand for energy, and the diversion of crops for bio fuels have all helped force prices upwards. The Indian government is now seeking to stop “speculation” in food by preventing Indians buying and selling certain food based contracts. Several Asian countries are imposing export bans on staple foods.

These responses are understandable but they are not going to solve the underlying problem. There are “financial” buyers of wheat and rice futures contracts, but it is difficult to distinguish a “speculative” buyer from a trade user of such contracts. If just a few countries seek to ban trading in such items, the trade will continue elsewhere in the world. It is unlikely that Chicago will shut down its commodities trading markets, and if it did farmers would be up in arms as well as speculators. Nor will export bans solve the problem. The country that imposes an export ban on Item A will still want to import Item B and will be relying on other countries not imposing export bans. If too many export bans are put in place the world will become poorer, as trade will be damaged.

The shortages and high prices are squeezing us all, but they are especially bad news for the poor. The prices going up are the prices of the basics – food and fuel. The answer has to be more production of both, to cater for the growing demands of a rapidly rising world population. The high current oil price is leading to more exploration and more oil finds. The high prices of grains should lead to more land going under the plough, and the adoption of more intensive methods of growing grains in developing countries. In the meantime the UN needs to redouble its efforts to help the poorest in the worst affected countries. The answer is not to move to protectionism, the system which intensified the slump of the 1930s.

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9 Comments

  1. Derek
    Posted May 8, 2008 at 10:45 am | Permalink

    Sorry I'm a jeremiah, you can't get away from inflation. It's like a balloon, you squeeze house prices down at one end of the balloon and food prices inflate at the other. Whilst at the same time the central banks are pumping ever more air into the balloon. You talk of protectionism being a bad idea, I agree. However, the injection of masses of liquidity could well come to be seen, in hindsight, as a futile central government attempt to improve things that ultimately is viewed to have exacerbated matters. As happened with Smoot-Hawley. Another example is the US federal government's tax rebate cheques. If you send one to everyone, it may improve sentiment briefly, but ultimately it's pointless and inflationary.

    The information I have to hand all points to non-food fmcg imported goods getting an awful lot more expensive.

  2. Tony Makara
    Posted May 8, 2008 at 11:04 am | Permalink

    The problems the world faces with the cost of fuel and food shortages around the globe ought to make every nation conscious of the need to try and supply its own domestic market where possible. Food security must be moved to the top of the political agenda. The rising prises caused by shortages and falling currencies are, in the long term, not going to be helped by cutting rates. Inflation will cause far greater problems and the emphasis must be set on maintaining price stability as the starting point for all other policy.

    The fact that Sterling has deliberately been kept overvalued now means that we dare not cut rates without letting inflation into the country on the back of imports. The correct policy now must be to try and maintain a steady differential between Sterling and the Euro to protect us from importing EU food-inflation. The future Conservative government must look at ways to substantially increase agricultural production, particularly with the aim of supplying our domestic market.

  3. mikestallard
    Posted May 8, 2008 at 6:34 pm | Permalink

    I am not competent to debate with you all on economics, I am afraid. What you say sounds about right though.

    Here in the some of richest farmland in the world where almost anything temperate will grow (asparagus now and strawberries soon) the fields are green with biofuels and yellow with rapeseed. Farmers have been leaving quite a lot of land unploughed up to now. Animals all went in the BSE/foot'n'mouth fiasco.
    And our farmers are trammelled by the most ridiculous rules coming out of the EU. The RSPB is dictating how they should plough and when so as not to disturb breeding birds in the dykes. Then there was the brilliant idea of the 10 metre conservation headland which now seems to have been dropped. Apparently farmers are doing more and more paperwork to get their CAP grants and, yes, even those were late under Margaret Beckett.

    Meanwhile Africa is breeding fast and Malthusian wars and famine are starting up. Apparently the Indians and Chinese are wanting meat. But, no, it is biofuels under the EU directive.

    And, let us remember, it is the French, our rivals, who are driving the CAP.

    In any commonsense world (and the world of farming in the Fens is not that world), production would be meeting demand.
    Once again, a challenge is not being met by the politicians who presume to interfere with the invisible hand.

  4. Tony Makara
    Posted May 8, 2008 at 11:20 pm | Permalink

    mikestallard, interesting point that you make about China. The Chinese are currently operating a no-strings trade policy in Africa and will do business with any regime so long as they can gain access to that continent's rich natural resources. Hu Jintao even described Africa as being a "feeder continent for the great Chinese economic project" this combined with talk of "ending western economic pre-eminence around the world" is very worrying and its about time western politicians began to understand the hegemonistic nature of the Beijing regime.

  5. APL
    Posted May 9, 2008 at 11:18 am | Permalink

    JR: "This week has seen more moves to ease the Credit Crunch in the USA."

    It is a mark of how desperate the Fed is that there are so many innovative credit facilities, typical of government it is offering a solution to the last problem, when confronted by something new government has no clue what to do. We have moved on from the credit crunch, this is now a solvency crisis.

    You were right when you said you cannot have inflation during a credit crunch, what is actually happening now is that liquidity is being provided by the central banks but not fast enough to keep up with the billions in asset value that is being destroyed.

    The cruel truth is, 'value' is being destroyed faster than it is being created. So yes, there is unlikely to be infaltion in the short term.

    You said the other day, the US economy is not in recession. Have you ever heard of a government giveing cash back to the tax payer? The US stimulus checks are another indicator of the desperation of the US government. They hope it will stimulate the economy, there is almost no chance of that, most people who recieve such a check, if sensible, will use it to pay down debt.

  6. John R
    Posted May 9, 2008 at 3:18 pm | Permalink

    Mr Redwood

    I find it quite interesting that for all the talk of $200 oil, these oil prices are not in least reflected in the equity markets. Shell, BP and the rest have been going sideways for years, stock price wise.

    This makes no sense, because although they are all short of crude oil, they do all produce at least some (which is just cash to the bottom line) and refining margins are holding up very well.

    This suggests that oil markets and equity markets have currently irreconcilable perspectives on the proper value of oil.

    I suspect that it is the equity chaps who have it right. There has been such a shortage, over the last few years, of places to put capital to work that amounts of it are presumably now finding their way into hedge funds whose idea of market participation is to buy short-dated oil. As such, the oil price now reflects not so much the supply and demand fundamentals of the energy business, so much as those of the investment business.

  7. David Jensen
    Posted May 9, 2008 at 9:53 pm | Permalink

    Dear Mr Redwood,

    The surge in interest in comodities by speculators is following the decline of property and leveraged buyouts of companies. It is fanned by the globalisation of information and finance and access to worldwide stocks/options of these comodities. It is here to stay albeit in a cyclical manner. You are a bright man, but I suspect that you advocate the market to set prices. In the context that I have set, that aint gonna help the poor. Those hedge funds rely on their huge salaries to offer a little charity.

  8. Bazman
    Posted May 10, 2008 at 7:36 pm | Permalink

    Funny how Libral conservatives are not so liberally Conservative when it comes to free trade across the world in food commodities. John redwood has been the exception here.
    Protectionism is rife because of rich Tory farmers sowing their two pences and harvesting fifty pound notes. Or not even doing that and being paid. How about the same subsidies for the car industries as they employ more people?

  9. Peter van den Berg
    Posted May 13, 2008 at 9:43 am | Permalink

    Did you see the recent article stating that potatoes were the answer to the current food shortages. they need little water; can grow in almost any climate, are nutricious & have a fast crop cycle. Once sushi & tortillas made with spuds are acceptable, corn & rice prices will drop fast

  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, He graduated from Magdalen College Oxford, has a DPhil and is a fellow of All Souls College. A businessman by background, he has been a director of NM Rothschild merchant bank and chairman of a quoted industrial PLC.

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