Can the Fed Drive Up Food Prices? Reply to Henderson
I have been putting off my reply to David R. Henderson for when I can “do it justice.” Well that’s not going to happen anytime soon, so let me fire off some quick thoughts…
Let’s refresh our memories as to David’s objections:
On Judge Napolitano’s “Freedom Watch” on March 25, Austrian economist Bob Murphy claimed that the unrest in the Middle East was due to rising food prices which in turn are due to the Fed printing money. I’m not sure about the rising food price/political unrest issue–that could well be true. But I’m pretty sure that the Fed printing money/rising food prices link is weak. When the Fed prints money, that raises the dollar prices of goods. But why would it raise the prices to people in the Middle East. All other things equal, the dollar would adjust downward and the prices of food to people in the Middle East would stay the same.
And I’m especially surprised to see an Austrian economist make this argument because isn’t one of the main things they offer to business cycle theory their insight that where the money enters the system matters? In other words, there are Cantillon effects from printing money. If the Fed increases the money supply by buying bonds, then you would expect bond prices to rise. It’s a long stretch to get from that to food prices.
If you want to account for changes in food prices, you should look to the demand and supply of food. So Bob would need to explain why printing U.S. dollars causes the demand for food to rise. I can see some spillover, but why would food prices rise more than other prices that closer in the chain to bond prices? Bob?
OK I have two main lines of response. First–and perhaps this will seem like cheating–I think a lot of countries either have an explicit peg to the dollar, or don’t want to let their currencies appreciate too quickly against it. So when Bernanke floods the world with dollars, this leads many other central banks to rev up their printing presses too. (I don’t know the exact countries off the top of my head, but here’s a discussion from 2010.)
Incidentally, this isn’t just my view. One of my favorite non-Austrian economists just wrote something very similar about price inflation generally, not just food:
Inflation is now a big and growing problem in emerging economies. Why? It’s the combination of the liquidity trap in advanced economies and the unwillingness of emerging nations to let their currencies rise.
The story runs like this: in advanced economies, the collapse of housing bubbles and the overhang of debt run up during the Great Moderation is leading to persistently depressed demand, even with very low policy interest rates. The result is low returns to investment; not much point in adding to capacity when you’re not using the capacity you have.
Meanwhile, emerging economies have plenty of demand, in part because they’re emerging, in part because they didn’t share in the big debt runup. So what the world economy “wants” to do is have large capital flows from North to South, and, correspondingly, large current account deficits in the emerging world — which would, of course, help the advanced economies recover.
But since the doctrine of immaculate transfer is false, the transmission mechanism by which capital flows get translated into trade balances has to involve a rise in the relative prices of goods and services produced in the emerging nations. The natural and easy way to get that would be via currency appreciation; but governments don’t want to see that happen. So the invisible hand is in effect getting the same result — gradually — by pushing up nominal prices in these countries.
Now as to the question, “Why would this be hitting food prices first, and not prices in general?” I think it’s because agricultural products are internationally traded. So they will be hit by currency changes first, with the prices of (say) haircuts rising much more slowly. That’s why exporters favor a weak currency, after all: if all prices adjusted at the same rate, then exporters wouldn’t benefit from a devaluation. (I explain all that here.)
So to recap my first line of defense: I am saying that the Fed and other countries who do not want to let their currencies appreciate against the dollar, have all partaken in a devaluation of their own currencies against the rest of the world. This has boosted the nominal prices of internationally traded goods in their economies, which includes oil and food.
Now on to my second line of defense: I think the Fed’s activities are fueling speculative hedging (not sure if “bubble” is appropriate, since it may very well be vindicated shortly) in various asset classes. Investors aren’t going to pour their money into dot-com stocks or real estate, and in this bleak environment it seems like a pretty safe bet are basic commodities and foodstuffs.
Let me put it this way: Does David at least acknowledge the possibility that the Fed’s activities have a decent fraction of investors worried about a crashing dollar, and that they have loaded up on gold as a defensive maneuver? Further, couldn’t this lead to a relative increase in the gold price against other goods and services, even in non-dollar currencies?
So if we can all understand how that might work, I don’t think it’s a huge stretch to say investors are bulking up not just on gold ETFs, but also wheat futures and the like. Sure, they’re not going to take physical delivery, but they wouldn’t take physical delivery of oil either. Sophisticated derivatives markets allow you to profit from price movements even if you have no interest in the underlying asset or commodity. (Note that in the comments of David’s original post, the quintessential von Pepe makes a similar argument.)
What evidence is there that the Fed is flooding the world with USD? Most of its new money is safely locked away in its reserves. Moreover, the growth rate in money supply (official M2 or Shadowstats M3) has been modest.
Also, in the case of oil, Stefan Karlsson (an Austrian economist) explains why its price rise cannot be explained by QE2:
http://stefanmikarlsson.blogspot.com/2011/04/role-of-fed-libya-in-more-expensive-oil.html
I never said QE2 explains all of the price rise in oil since it was implemented. I talk about Libya here.
But surely the more than tripling of oil prices since December 2008 has something to do with the Fed.
“But surely the more than tripling of oil prices since December 2008 has something to do with the Fed.”
That’s precisely what is in dispute here. You claim it must be the Fed, yet you have nothing to back it up.
As for the oil price, it has NOT tripled since December 2008. At least not according to the WSJ. It was $65pb compared to $109 now – not even double. But why did you pick that date? Why not ‘since July 2008’ when it was higher than today at $140pb?
Source:
http://online.wsj.com/mdc/public/npage/2_3051.html?mod=2_3002&sid=2271843&page=commodities
In late December crude was $35/bl, according to the EIA.
I’m not sure what that WSJ thing is graphing. Is it the futures price for May 2011 oil? Maybe the contract for that was selling at $65 back in Dec 08, but the spot price (and short-term futures which is what the EIA charts I think) were in the mid-$30s back then. I remember the daily oil quotes at the time, as well as the EIA chart I linked.
And the reason I didn’t pick “since July 2008” was that the Ber-Nank hasn’t been going nuts with the monetary base since July 2008.
Mmm, I don’t know what the WSJ is measuring either.
In any case, the EIA data shows that the price of oil before Bernanke ‘went nuts’ was higher than after he ‘went nuts.’ This is more consistent with the view that ‘going nuts’ means printing a ton of money in one building, then transporting it to a vault in another building. In other words, the money has simply not leaked into the economy, at least not yet.
Did you have a look at Shadowstats’ M3?
http://www.shadowstats.com/alternate_data/money-supply-charts
Note how it peaked in 2008 and then collapsed, and is still contracting. This is incompatible with your ‘the Fed is flooding the economy’ story.
BTW, I went to the mises.org website to look at the latest TMS chart (which includes M1, M2, M3 and MZM), but it hasn’t been updated since December 2009! What’s going on there?
http://mises.org/content/nofed/chart.aspx?series=TMS
I’m not sure I get your point about oil. If oil falling rapidly from $140 to $35 isn’t explained by the Fed, why do you think it’s obvious that oil rising less rapidly from $35 to $105 is due to Fed action.
Anecdotaly here in Australia I am paying $4.20 for the hot chips I get at lunch at work every now and then. 10 years ago when I came to Australia they were $1.50. Somehow I don’t think its a potato shortage causing these problems…and our dollar is stronger than the U.S one now!
There are plenty of other examples too.
Avram,
There are counter-examples too, e.g. Coles selling milk for $2 a litre compared to around $3.30 a few months ago. And although the price of petrol is around $1.35 per litre, if not for the high dollar, we would be paying around $2.20 per litre. Moreover, have you seen the price of TVs lately? A friend of mine recently bought a 50″ plasma HD for $800, 3 years ago you would have been paying around $4,000!!!
Oh look honey, it’s another person bringing technology-related price declines in precisely the cases where they need to hide inflation.
That’s nice, dear.
Naw give him credit where credit is due: Milk isn’t technology related afaik, but I don’t seem to ever recall milk hitting $3.30 a litre like he says anywhere except gas stations. I’m paying $1.45 / litre to this day.
Most of the food price increases I’ve seen are in things like fruits, vegetables, meats. Less so with finished produce although now when I buy a pack of crisps I only get 185grams instead of the old usual 200grams.
Besides all this the RBA has been ultra conservative in monetary policy, and we still have one of the highest official targets in the world. To say nothing of how actually unwilling they were to enter the markets and lower the interest rate to where they said they wanted it. So a lot of prices that might be going up if we were more strongly pegged to the USD, like gas, aren’t.
Avram,
Oops, I just realised my mistake. The $3.30 price was correct, but that was for 2L plastic containers. Coles are now selling these for $2 each, i.e. $1.00 per litre.
I agree with the rest of what you say. The relatively lower inflation is not just technology-related, but also related to RBA monetary policy and the higher USD.
For example, since Jan 2009 the price of gold in USD has increased by nearly 70%, but in AUD by only 11%.
“First–and perhaps this will seem like cheating–I think a lot of countries either have an explicit peg to the dollar, or don’t want to let their currencies appreciate too quickly against it. So when Bernanke floods the world with dollars, this leads many other central banks to rev up their printing presses too.”
I think you got the causation wrong, or at least you’re not putting the blame where it should be A PEG LEADS to other central banks to rev up their printing press when Bernanke revs his up. Bernanke doesn’t force any country to peg their currency to the dollar so QE could not possibly be blamed for higher food prices outside the US. The Fed isn’t leading anything. You’re putting the blame on the wrong central banker.
And as Dean Baker explains, a weakened dollar should actually lead to lower prices for food sold under long term contracts in the middle east.
http://www.cepr.net/index.php/blogs/beat-the-press/the-washington-post-is-badly-confused-about-international-trade-blames-bernanke-for-higher-food-prices
should be. [period goes here]
Jones, the people rioting in the Middle East aren’t buying 6-month wheat futures. And anyway Baker explicitly acknowledged what I said:
Yes, food commodities, like other commodities, are typically traded in dollars, but this means absolutely zero in terms of food price inflation in other countries unless their governments have made a decision to link their currency to the dollar.
As someone who disagrees with nearly 100% of what Mr. Murphy says about inflation and the Fed, I think he gets some of this right. Especially this part:
Now on to my second line of defense: I think the Fed’s activities are fueling speculative hedging (not sure if “bubble” is appropriate, since it may very well be vindicated shortly) in various asset classes.
This is the portfolio rebalancing channel.
As more of the risk free asset gets removed from the private sector, it forces investors out the risk curve, driving prices higher than fundamentals justify. The Fed is not creating anything new, on a net basis, (they are not simply printing money – there is an asset removal on the other side) but they are forcing folks to take on more risk than the otherwise would. This is how the Fed can influence food prices…its unfortunate for EM citizens that investors have focuses on this asset class, but the financialization of the commodity market has been a boom for Wall Street banks. Many of these structured commodity products (ETFS) are very similar to the beginnings of the financial engineering that took place at the beginning of the sub prime financial engineering…
“As more of the risk free asset gets removed from the private sector, it forces investors out the risk curve, driving prices higher than fundamentals justify. The Fed is not creating anything new, on a net basis, (they are not simply printing money – there is an asset removal on the other side) but they are forcing folks to take on more risk than the otherwise would.”
This almost sounds like an endorsement of the ABCT. The Fed enticing banks and financial institutions to engage in risky behavior through various mechanisms like lowering of the interest rate or increasing excess reserves. I am not entirely sure what you are stipulating here AP.
“I am not entirely sure what you are stipulating here AP”
The Fed, with the help of the Street, is creating asset bubbles in commodities.
Is China facing a Hobson’s Choice?
http://www.cato.org/pub_display.php?pub_id=12825
One way to test Bob’s first response would be to look at countries that don’t have a dollar peg vs. ones that do. If Bob is right, food prices should be going up a lot more in countries with pegs than in countries without.
This is what I said in response to David Henderson’s original post:
“I don’t buy the notion that world food prices are going up because of US monetary policy. Food prices expressed in US$ may (and I stress may because we don’t have good measures of price inflation) be going up because of US monetary policy but prices in other currencies are going up either because of foreign countries’ decision (misguided in my view) to use monetary policy to target their exchange rate (rather than domestic price inflation) or because of real factors (e.g., poor harvests in China and Russia, IIRC, ethanol subsidies and the growing wealth of emerging nations and its implications for changing diets). My view is that food price increases are largely a real phenomenon, i.e., a relative price increase. I can see that the relative price effects would be exacerbated by poor foreign monetary policy though.
I think it is likely that the responses by global policy makers to the financial crisis have caused many investors to have lost a degree of confidence in fiat currencies or, at a minimum, to want to hedge against the possibility of a massive loss in confidence in the future. The primary risk here is not monetary policy per se but mammoth budgetary deficits caused by various bailouts and failed fiscal stimulus and the possibility either of default or monetization. The shift away from the US$ as the reserve currency that is now in its earliest stages is part of this.
Given the lack of an immediate substitute for the US$ as a reserve currency and a desire to hedge against the major fiat currencies in general, these investor concerns may well have caused a (real) portfolio shift towards storable commodities. The monetary metals are obvious candidates, as are oil, copper, land, etc. I don’t see food as being one of these, although, in this environment, and given the real price impetus I noted above, authoritarian governments seeking to protect themselves against civil unrest may have shifted assets into the stockpiling of certain foodstuffs.”
David,
Good analysis. However, I have to wonder about your last sentence: “authoritarian governments seeking to protect themselves against civil unrest may have shifted assets into the stockpiling of certain foodstuffs.”
If that were the case, then presumably authoritarian governments wouldn’t be getting overthrown due to food riots.
Thanks Blackadder. I wasn’t suggesting that authoritarian governments had in fact stockpiled food. Certainly we can infer that many did not, although I believe I have read that China does have stockpiles and may have reduced its exports due to concerns about domestic food supplies. In any case, the point I was trying to make was more that, to the extent any party was stockpiling food (and this contributing to real price increases), it was likely governments in command-type or centrally directed economies.