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From speculation to starvation

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Rising food prices have been a feature of recent inflation numbers in Australia, with the food component of the Consumer Price Index (CPI) rising by nearly 6% over the past year. With food representing just under 20% of the expenditure base on which the CPI inflation measure is calculated, the higher cost of food has been a significant contributor to the rise in inflation; and subsequent lifting of interest rates designed to control this inflation.

Supermarket shelves don’t tell the full story

However, the 6% rise in food prices experienced by Australian consumers is only a very small part of the story being told on global food markets today. A large proportion of what Australians end up paying for food items is really a reflection of the costs of getting food items to the supermarket shelves, rather than the underlying cost of the actual food produce itself. Costs such as packaging, transport, wholesaling and retailing will often dwarf the physical cost of the food being purchased. As a result, when the underlying cost food raw materials increases, there will normally only be a muted percentage rise in the price paid for food items by the end Australian consumer.

In reality, the global price for many food-based agricultural commodities has escalated to extraordinary new heights over the past year. The chart below traces the movement in the Reserve Bank’s Commodity Price Index for rural items. This Index measures prices for various rural commodities and weights these prices based on the rural item’s importance to Australia’s export revenue. It can be seen from the chart below that rural items measured by this Index have jumped in price by nearly 30% over the past year. Rising wheat prices have been a major contributor to this increase.

The rise in price for some specific rural commodities has been even more spectacular than that shown by the above Index series. From a global perspective, the most significant change in food prices has been that relating to rice. In just the last 6 months, the price of rice on global markets has more than doubled. With rice a staple food for such a large proportion of the world’s population, the impact of the sudden price boom is far reaching.

Supply, demand and speculation

A rise in the price of agricultural commodities had been expected by many observers for some time (see Feature Article of View from the Hill in February 2007). The economic development of China and India was always expected to lead to the generation of greater demand for agricultural items (in a similar fashion to what has happened with mineral and energy based commodities). As consumers become wealthier, they will increase their consumption across a wide range of categories of goods and services, including food.

On the supply side, economic development and wealth generation is also normally associated with a shift from a subsistence agricultural society to a more urbanised society where individuals are less like to produce their own food. There has also been the increasing use, or planned use, of agricultural land for the production of bio fuels, which has threatened the capacity of the world to generate additional supplies of rural commodities.

However, as seems to be the way these days on global markets, the extent and speed of the upward movement in price for many items has been significantly greater than what could be explained by fundamental supply and demand forces. It would appear that speculators have become more heavily involved in the futures markets where contracts over agricultural commodities are traded. As prices have increased, it is likely that more and more speculators have been attracted to these markets, possibly exacerbating (or at the very least speeding up) the extent of price change.

Implications of higher food prices

Whilst there may be some element of recent food price rises that could be associated with a “speculative bubble”, there is little doubt that much of the increase is likely to have some permanency due to the demand and supply balance described above. The change in the level of food prices will lead to a change in the distribution of wealth from food consumers to food producers.

The impact on those in developing nations, who are unfortunate enough not to produce their own food and typically devote large proportions of income to food purchase, has been particularly severe. Unaffordable food and concerns over starvation has led to riots in several countries (eg Haiti) and the hording of whatever food is available. There has been a significant decline in the effective relative income of these nations and no doubt a growing risk of political unrest as effective living standards decline.

Far more fortunate, Australia, as a net food exporter, is expected to be a beneficiary of the upward shift in food prices – albeit with a temporary increase in inflationary pressures as a result. The contribution to economic growth from the rural sector can be expected to increase with increased profits from those involved in the production of food.

Brad Matthews, Hillross Economist

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