Most Popular
1. THE INFLATION MONSTER is Forecasting RECESSION - Nadeem_Walayat
2.Why APPLE Could CRASH the Stock Market! - Nadeem_Walayat
3.The Stocks Stealth BEAR Market - Nadeem_Walayat
4.Inflation, Commodities and Interest Rates : Paradigm Shifts in Macrotrends - Rambus_Chartology
5.Stock Market in the Eye of the Storm, Visualising AI Tech Stocks Buying Levels - Nadeem_Walayat
6.AI Tech Stocks Earnings BloodBath Buying Opportunity - Nadeem_Walayat
7.PPT HALTS STOCK MARKET CRASH ahead of Fed May Interest Rate Hike Meeting - Nadeem_Walayat
8.50 Small Cap Growth Stocks Analysis to CAPITALISE on the Stock Market Inflation -Nadeem_Walayat
9.WE HAVE NO CHOICE BUT TO INVEST IN STOCKS AND HOUSING MARKET - Nadeem_Walayat
10.Apple and Microsoft Nuts Are About to CRACK and Send Stock Market Sharply Lower - Nadeem_Walayat
Last 7 days
Why PEAK INFLATION is a RED HERRING! Prepare for a Decade Long Cost of Living Crisis - 9th Aug 22
FREETRADE Want to LEND My Shares to Short Sellers! - 8th Aug 22
Stock Market Unclosed Gap - 8th Aug 22
The End Game for Silver Shenanigans... - 8th Aug 22er
WARNING Corsair MP600 NVME2 M2 SSD Are Prone to Failure Can Prevent Systems From Booting - 8th Aug 22
Elliott Waves: Your "Rhyme & Reason" to Mainstream Stock Market Opinions - 6th Aug 22
COST OF LIVING CRISIS NIGHTMARE - Expect High INFLATION for whole of this DECADE! - 6th Aug 22
WHY PEAK INFLATION RED HERRING - 5th Aug 22
Recession Is Good for Gold, but a Crisis Would Be Even Better - 5th Aug 22
Stock Market Rallying On Slowly Thinning Air - 5th Aug 22
SILVER’S BAD BREAK - 5th Aug 22
Stock Market Trend Pattren 2022 Forecast Current State - 4th Aug 22
Should We Be Prepared For An Aggressive U.S. Fed In The Future? - 4th Aug 22
Will the S&P 500 Stock Market Index Go the Way of Meme Stocks? - 4th Aug 22
Stock Market Another Upswing Attempt - 4th Aug 22
What is our Real Economic and Financial Prognosis? - 4th Aug 22
The REAL Stocks Bear Market of 2022 - 3rd Aug 22
The ‘Wishful Thinking’ Fed Is Anything But ‘Neutral’ - 3rd Aug 22
Don’t Be Misled by Gold’s Recent Upswing - 3rd Aug 22
Aluminum, Copper, Zinc: The 3 Horsemen of the Upcoming "Econocalypse" - 31st July 22
Gold Stocks’ Rally Autumn 2022 - 31st July 22
US Fed Is Battling Excess Global Capital – Which Is Creating Inflation - 31st July 22
What it's like at a Stocks Bear Market Bottom - 29th July 22
How to lock in a Guaranteed 9.6% return from Uncle Sam With I Bonds - 29th July 22
All You Need to Know About the Increase in Building Insurance Premiums for Flats - 29th July 22
The Challenges on the Horizon for UK Landlords - 29th July 22
The Psychology of Investing in a Stocks Bear Market - 26th July 22
Claiming and Calculating The Research and Development Tax Credit - 26th July 22
Stock Market Bearish Test - 26th July 22
Social Media Tips and Writing an Effective Call to Action - 26th July 22
Has Rishi Sunak Succeeded in Buying His Way Into No 10 - Fake Tory Leadership Contest - 26th July 22
The Psychology of Investing in a Stocks Bear Market - 26th July 22
Claiming and Calculating The Research and Development Tax Credit - 26th July 22
Stock Market Bearish Test - 26th July 22
Social Media Tips and Writing an Effective Call to Action - 26th July 22
Has Rishi Sunak Succeeded in Buying His Way Into No 10 - Fake Tory Leadership Contest - 26th July 22

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Food Price Inflation, Monetary Policy & Financial Markets

Stock-Markets / Food Crisis Apr 29, 2008 - 04:23 AM GMT

By: John_Mauldin

Stock-Markets Best Financial Markets Analysis ArticleThe second is by good friend and Maine fishing buddy David Kotok, the chief investment officer of Cumberland Asset Managers ( www.cumber.com ). He was recently in Africa where he met with the head of the central bank of a small country with headline inflation of 10%. The problem is that "core inflation" is 5% and food inflation is 15%, yet accounts for 50% of the GDP. He asked a group of financial thinkers (including your humble analyst) to ponder what that central banker should do. Do you set high rates and target overall inflation or set lower rates and not worry about food inflation.


Why should we worry about inflation in a small African country? Because the principles are the same, and it makes a real difference where the Fed comes down at the end of the day on this very question.

This week's reading should be very helpful and thought-provoking. I hope you enjoy this read as much as I did.

John Mauldin, Editor
Outside the Box

Food Price Inflation, Monetary Policy & Financial Markets

By David Kotok

Suddenly food price inflation has become the premier hot topic. The media is now attuned to food issues including emerging market country riots.

In the US, the politicians are gearing up to castigate the speculators and blame everyone but themselves. They conveniently forget that they are the ones who passed the ethanol subsidy and they are the ones who appropriate taxpayer money to pay farmers not to grow crops. And so the political circus begins.

Notice how the three presidential candidates are silent on how the US ethanol subsidy has caused a food price explosion in grains. They avoid the issue of US policy starving many in the world. 1 billion very poor people sustain themselves on $1 or less a day. We have doubled the cost of their food.

Ethanol directly impacted corn which, in turn, also drove up maize. In addition, the substitution of wheat and rice are not easily occurring because of crop issues and concomitant price inflation in those items.

Well Cumberland is in the financial market and money management business. We eat food. We don't grow it and we don't process it. So let's try to inject some serious monetary policy issues into this media hysteria and political cacophony.

In the mature countries, food is a minor portion of the price index. And some of the food costs originate from eating out and some come from food processing. Processed food cost is heavily dependent on the inputs which are non-food items. Labor, machinery, transportation and distribution all come in to play. So in the mature countries we see that the food price inflation may be topical and attention getting but it is not a crisis.

Also, the major mature countries are mostly in food surplus. In the US we are very efficient in running our agriculture enterprise. We actually pay farmers not to till their soil. This is dumb. It occurs only because of our sorrowful Congress who has learned how to bribe the farm belt for votes at the expense of the rest of us.

In the US food has a 14% weight in the consumer price index. Compare that with Canada at 17%, the Euro zone at 16%, England at 11% and Japan at 25%. Only Japan lacks the fullness of food self sufficiency. Sure, food price inflation is important. But it is not the most important issue in these major economies.

The reverse is true for the emerging markets. In some of them the food price component is as much as half the price index. In a few it is above half. Since many of these economies are open to some degree, the importation of food price inflation is hitting them particularly hard. Some are responding with tariff adjustments. Others have actually embargoed food exports. Of course they ultimately make matters worse when they restrict world trade and in the end all suffer because of this protectionism.

What about monetary policy?

Here is where it gets difficult. We will admittedly simplify now and we acknowledge to our critics that we know there are second order effects and are ignoring them to make our point. In our view, monetary policy cannot easily and directly address food price inflation when the source of the inflation is in the raw food commodity. This is also true for energy costs when the source is in the oil or natural gas. The whole concept of "core" inflation vs. total inflation originates in this notion that monetary policy should be directed at the price level changes it can affect.

Let's get to the inflation problem in an emerging economy. Our example is imaginary for simplicity's sake. But it reflects characteristics that are very similar to many countries and regions in the emerging markets of the world.

We developed this simple and theoretical case study and then sent it to a number of economist friends. We suggested that following facts: the economy in question is a small and open emerging market. The food price component is 50% of the price index and is inflating at 15%. The non-food component is inflating at 5%. Thus the overall index is inflating at 10%. In this small and open economy, the main items in the food component are based on maize; therefore, the US ethanol policy which has raised the corn priced has also pressured an increase in the maize price.

Suppose you are the governor of the central bank. You have to set your policy interest rate. Do you base that decision on overall inflation rate of 10% or on the core inflation rate of 5%? Or are you going to confront the food inflation rate of 15%. Let's further assume that your economy is growing at a trend rate of 5% and all other aspects are in trend or neutral position. You have no negative output gap and no above trend pressures. Your only direct problem is what to do about inflation.

My economist friends who answered offered a suggested policy rate as low as 6% and as high as 13.5%. The answers were about equally divided and the respondents sample size is over 20. The distribution of answers was distinctly bi-modal. About half the answers were bunched in the lower range of 6%-8%; the other half were in the double digit area between 11% and 13.5%.

The divided views centered on whether or not to target food, ignore food, or blend policy. No one wanted to set the interest rate above the 15% food price inflation. Nearly all acknowledged that this central bank would have difficulty in communicating whatever it decided. Most respondents worried about changes in inflation expectations because of the complexity of this issue. Most believed the citizens in the country would not understand the monetary policy dynamics that led to the decision.

Some worried that setting the policy interest rate in double digits would impose a very high financing cost on the non-food portion of the economy and cause it to go into recession. They argued that the real (inflation-adjusted) rate of interest for that non-food half of the economy would be 7% or so. That would set the threshold of finance too high.

Others argued that the monetary policy expectation effect would cause the rate of inflation to accelerate if the policy rate was not set in double digits. They were willing to take the recession in the non-food area in order to keep inflation expectations under control. No one mentioned substitution effects. Perhaps that was overlooked. Or it may be because rice and wheat are not easy cultural substitutes and those grains are each experiencing their own price pressures.

In sum, almost two dozen folks with some monetary economics expertise were equally divided on this technical question. It is a question that impacts billions of citizens in this world and many countries, their governments, their currencies and, possibly, their political stability.

We do not know the correct answer. Our view would support the lower interest rate and we would focus on the non-food portion of the economy but we can argue the other side with equal vigor. For us a lot would depend on how the food price inflation spreads into wages and if it could trigger a broader wage/price spiral.

In many respects this question is now being asked of the major and mature economy central banks as well. It appears that the European Central Bank (ECB) favors the higher mode while the US Federal Reserve is positioned in the lower one. For the emerging markets it appears that there is quite a mix of policy and that it is made more complicated by the management of each currency's foreign exchange rate. In sum, our simple case study is actually quite complex when applied in the real world.

David R. Kotok, Chairman and Chief Investment Officer

 

I trust you enjoyed this week's Outside the Box. And for the record, I thought rates in our hypothetical African country should be at the lower end. Targeting food inflation with high interest rates would hammer the productive, job creating portion of the economy. I have been to 15 countries in Africa and they are in desperate need of jobs. Better to target inflation through control of the money supply and encourage capital formation and foreign direct investment. But it is a tough question.

Your glad I don't have to be a African central banker analyst,

By John Mauldin

John Mauldin, Best-Selling author and recognized financial expert, is also editor of the free Thoughts From the Frontline that goes to over 1 million readers each week. For more information on John or his FREE weekly economic letter go to: http://www.frontlinethoughts.com/learnmore

To subscribe to John Mauldin's E-Letter please click here:http://www.frontlinethoughts.com/subscribe.asp

Copyright 2008 John Mauldin. All Rights Reserved
John Mauldin is president of Millennium Wave Advisors, LLC, a registered investment advisor. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions. Opinions expressed in these reports may change without prior notice. John Mauldin and/or the staff at Millennium Wave Advisors, LLC may or may not have investments in any funds cited above. Mauldin can be reached at 800-829-7273.

Disclaimer PAST RESULTS ARE NOT INDICATIVE OF FUTURE RESULTS. THERE IS RISK OF LOSS AS WELL AS THE OPPORTUNITY FOR GAIN WHEN INVESTING IN MANAGED FUNDS. WHEN CONSIDERING ALTERNATIVE INVESTMENTS, INCLUDING HEDGE FUNDS, YOU SHOULD CONSIDER VARIOUS RISKS INCLUDING THE FACT THAT SOME PRODUCTS: OFTEN ENGAGE IN LEVERAGING AND OTHER SPECULATIVE INVESTMENT PRACTICES THAT MAY INCREASE THE RISK OF INVESTMENT LOSS, CAN BE ILLIQUID, ARE NOT REQUIRED TO PROVIDE PERIODIC PRICING OR VALUATION INFORMATION TO INVESTORS, MAY INVOLVE COMPLEX TAX STRUCTURES AND DELAYS IN DISTRIBUTING IMPORTANT TAX INFORMATION, ARE NOT SUBJECT TO THE SAME REGULATORY REQUIREMENTS AS MUTUAL FUNDS, OFTEN CHARGE HIGH FEES, AND IN MANY CASES THE UNDERLYING INVESTMENTS ARE NOT TRANSPARENT AND ARE KNOWN ONLY TO THE INVESTMENT MANAGER.

John Mauldin Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in