Keep an eye on China's grain productionFood shortages and inflation
HONG KONG The world may soon pay a high price for years of low global food prices resulting in large part from European and U.S. farm subsidies. The winners could include China's long-exploited farmers.
We should remember that food shortages were second only to oil prices in causing the huge global inflation of 1973 to 1975, which resulted in a collapse of financial asset prices and pushed the global economy into deep recession. Then, as now, the surge in commodity prices followed a period of easy money and rapidly rising financial markets.
History is threatening to repeat itself. Despite a hoped-for small rise this year, China's grain output is still some 12 percent below its peak, and the country is experiencing another large grain deficit. Most of India is still anxiously awaiting a belated monsoon. Unless it comes soon, India's ability to export food will be in jeopardy. Australia, too, has another drought.
While both India and China have huge grain stocks, the interlinkage of poor local harvests and tight international supplies is clear enough. The revival of inflation in China is due more to food prices - up 30 percent over a year ago - than to oil and other minerals.
That may not seem important for rich nations, for whom raw food prices are a tiny part of the price index. However, in an interdependent world, and especially one in which China plays a major role as supplier of manufactures, food prices are the beginning of an inflation chain.
The 30 percent rise in grain prices in China is spurring 4 to 5 percent or more consumer price inflation, which thus requires wage increases well ahead of productivity growth. Those additional wage costs are on top of higher prices for oil, steel, copper, plastics, etc.
Sooner or later these will be reflected in export prices and hence in a significant portion of retail sales in the United States. Inflation could again become embedded.
Given China's extremely competitive position in labor-intensive manufacturing, it is unlikely to suffer significant loss of market share by raising prices. Alternative suppliers are facing many of the same cost pressures or have currencies that have appreciated against the dollar.
The good news is that in the short run farmers in China and elsewhere will see their incomes rise, slightly redressing China's immense urban-rural income gap. The longer-term opportunity is that it will lead to investment in China to boost rural labor productivity, create off-farm employment, and promote the pricing of China's scarcest resource - water.
Whatever the long term outcome, today's reality is that real food and commodity shortages exist side-by-side with excess global liquidity and low interest rates.
It is not a comfortable combination, and it could well get worse if the weather compounds man's self-created problems.