Monday, February 07, 2011

What is driving the Middle Eastern social unrest? It looks like food prices.

What has caused the Egyptians to revolt against Mubarak at this time? Paul Krugman lays the blame on bad weather.
While several factors have contributed to soaring food prices, what really stands out is the extent to which severe weather events have disrupted agricultural production. And these severe weather events are exactly the kind of thing we’d expect to see as rising concentrations of greenhouse gases change our climate — which means that the current food price surge may be just the beginning.

Now, to some extent soaring food prices are part of a general commodity boom: the prices of many raw materials, running the gamut from aluminum to zinc, have been rising rapidly since early 2009, mainly thanks to rapid industrial growth in emerging markets.

But the link between industrial growth and demand is a lot clearer for, say, copper than it is for food. Except in very poor countries, rising incomes don’t have much effect on how much people eat.

It’s true that growth in emerging nations like China leads to rising meat consumption, and hence rising demand for animal feed. It’s also true that agricultural raw materials, especially cotton, compete for land and other resources with food crops — as does the subsidized production of ethanol, which consumes a lot of corn. So both economic growth and bad energy policy have played some role in the food price surge.

Still, food prices lagged behind the prices of other commodities until last summer. Then the weather struck.
In his blog, Krugman expands on this idea.
First of all, I don’t have any particular faith that markets necessarily get things right. Some readers may remember that I was almost all alone back in 2000-2001, declaring that the California energy crisis reflected market manipulation, not fundamental shortages; and I took a lot of heat back in 2005 for warning that we had a huge housing bubble.

So this isn’t about a priori belief in markets; it’s about whether we see the “signature” of a speculation-driven price surge.

Many people on the “speculators did it” side like to point to financial data, especially large purchases of futures by various players. But food is a physical commodity, and plays in the financial markets can only move the price to the extent that they affect physical flows and stocks.

Here’s my exotic model of the market for a physical commodity: [Go to his blog to see the simple supply demand graph.]

OK, how can speculation affect this picture? The answer is, it has to work through accumulation of inventories — physical inventories. If high futures prices induce increased storage, this reduces the quantity available to consumers, and it can raise the price. And you can, in fact, argue that something like this has been happening for cotton and copper, where there are apparently large and growing inventories.

But for food, it’s just not happening: stocks are low and falling.


So if and when I see signs that speculation is really driving up prices, I’ll say so. But the signature just isn’t there right now.
This looks like good data-driven analysis to me. Until I see evidence to the contrary this works.

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