Monday, July 16, 2007

Food Prices are Rising Worldwide Causing Inflation Problems

Excerpts below from the Bloomberg article comes at a very opportune time as many are debating the value of the Fed using the core inflation rate to set monetary policy. As stated before in previous posts the use of core inflation can give a distorted picture of how the economy is performing. Also I realize it is more fun (and topical) to discuss the real estate market and the credit markets, but inflation is a much more insidious problem. Having witnessed the high inflation rates of the 1970s and early 1980s first hand, inflation issues are far more important to the long term health of the economy than the unraveling real estate market. Lastly, this article ties in well with this Weekend's Contemplation.

The fastest increase in food-commodity prices in at least a decade has already led monetary authorities in England, Mexico, Chile and South Africa to lift borrowing costs. It is also sowing doubts about the U.S. Federal Reserve's focus on core inflation, which excludes food and energy, and about China's gradual approach to tightening credit.

As Fed Chairman Ben S. Bernanke prepares to deliver his semiannual report to Congress this week, central-bank officials worldwide are anxious that climbing costs may trigger consumer concerns about faster inflation. To keep them from being self- fulfilling, some of the biggest economies might have to push interest rates higher.

An unprecedented surge in global demand is behind the 23 percent rise in food prices that the International Monetary Fund recorded during the last 18 months. ``We haven't seen anything on this scale before,'' says Martin von Lampe, an agricultural economist in Paris at the Organization for Economic Cooperation and Development.

The demand, triggered in part by the increasing use of agricultural commodities to make ethanol and other substitutes for crude oil, may keep prices high for years. The OECD sees U.S. output of corn-based ethanol and European consumption of oilseeds for biofuels doubling by 2016.
Chinese and Brazilian production of ethanol will expand even faster, it said in a July 4 report with the United Nations' Food and Agriculture Organization.

Rising prosperity in China and other emerging nations is also spurring demand, particularly for value-added items such as meat and dairy products, the report said.

``We are sitting on structural changes that will affect agricultural prices for a long time to come,'' Paul Polman, chief financial officer of Vevey, Switzerland-based Nestle SA, the world's largest food company, said last month.

With prices of many everyday items starting to rise, the danger is that consumers and companies will become more pessimistic about the outlook for inflation.

``Nothing affects consumer inflation expectations more than food,'' says Richard Yamarone, chief economist at Argus Research in New York. ``Not everybody has to drive to work, but everybody wakes up and has breakfast.''

Bernanke has repeatedly highlighted the importance of those attitudes in carrying out monetary policy. ``The state of inflation expectations greatly influences actual inflation,'' he said in a July 10 speech in Cambridge, Massachusetts.

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