Artificial Inflation

• Posted by Jeff Carter
• on January 28th, 2011

Inflation is really tricky. What is known is that the US Federal Reserve has tried to get a little inflation going via its monetary policy. Central banks in other countries, namely the UK and Japan have tried to inflate.  Many governments have passed regulatory policy that is inflationary.

In the BRIC countries, they are trying to deflate. China has raised interest rates and cut subsidies for housing. Cheap money is giving monetary policy planners fits. Cheap capital is leaving the higher cost countries and finding a home in the developing world. It sets up a dangerous Jenga tower. If countries that are seeing an influx of capital don’t aggressively manage growth, the tower will topple and economies destroyed.

So far, countries realize what’s happening and are trying to do avoid that.

The other side effect of all this is upward pressure on food prices. Food stocks in many staple goods were low because of terrible weather. Wheat, coffee, cocoa, sugar, soybeans all had rough crops worldwide last year.  Coal prices are increasing because of the floods in Australia.  Meanwhile, because of the 2008 financial crisis, various countries trade policies and regulatory policies, protein farmers culled their herds so overall meat stocks were down. There are simply less chickens, less hogs and less cattle wandering around-unless your in India on the cattle part-just kidding.  Energy prices are higher because some governments, namely the US, have regulated so no one can get new supplies.

Tunisia, Algeria, and even Egypt have seen citizen protests. A lot of the unrest came from the high cost of food staples, primarily sugar. A little campfire has turned into a big bonfire. Maybe we should call this march for independence in North Africa the Sugar Rebellion?

Other governments seeing what has gone on have sprung into action. Today’s FT has a good article on it.  In virtually every food commodity, there has been panic buying this year at one time or another.  Governments across the world have reacted by setting up export restrictions, import quotas, duties and tariffs, and changes in regulations.  Now many of them have begun hoarding.  Saudi Arabia and Algeria have stepped up wheat purchases.  Smaller countries like Bangladesh and Indonesia are hoarding rice.  South Korea is exploring the idea of setting up it’s own internal commodity arm that would act like a sovereign wealth fund, but instead it would secure raw material inputs for its economy.

Governments cannot risk an uprising from their people.  They don’t want a “Let them eat cake,” moment, so they are overbuying to make sure that people don’t riot because of food.  Governmental moves only fan the flames of fear.

The US is not immune.  Our ethanol policy has raised the price of corn significantly.  40% of our corn crop goes to fuel, when it could be going to feed people or livestock. Increased feed prices have cut livestock profit margins, decreasing the incentive for ranchers and growers to increase production.  Because sweeteners can be made from corn, ethanol policy indirectly impacts the price of sugar.  The bad sugar crop found less raw material for substitutes.

Mini trade wars in all kinds of agricultural products have been touched off over the past few years.  Mexico, Canada and the US had a little dust up over pork.  Russia and the US have had little fist fights over chicken and pork.

Robert Lucas received the Nobel Prize for Economics in 1995. He has done a lot of work on monetary policy and inflation.  His lecture is worth reading all the way through, but here is an excerpt from his conclusion.

“The main finding that emerged from the research of the 1970s is that anticipated changes in money growth have very different effects from unanticipated changes. Anticipated monetary expansions have inflation tax effects and induce an inflation premium on nominal interest rates, but they are not associated with the kind of stimulus to employment and production that Hume described. Unanticipated monetary expansions, on the other hand, can stimulate production as, symmetrically, unanticipated contractions can induce depression.”

No doubt, the world has expected inflation since the stimulus was passed in March of 2009. There is a litany of economic evidence to predict the outcome of such irresponsible fiscal and monetary policy. People changed their behavior based on future expectations.  But, in the short run, the prices of goods and services didn’t increase as they might have expected.  Inflation from 2009-2010 was flat, or negative in a lot of cases.

In this case, inflation has been caused not by individuals pushing up the cost of goods through demand, but by really bad luck on weather and by really poor government policies putting artificial constraints on supplies.

What’s the remedy?  Change government policy, and pray for good weather.  No one controls the weather.

ADDENDUM

In sort of a companion idea to the inflation I was writing about above, John Taylor wrote an excellent piece in the WSJ today on government policy-namely that we have shot ourselves in the foot.  Changing policy will change outcomes.

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