High oil prices and food inflation come togetherHigh oil prices and food inflation come together

(AFP)   

 

The price of wheat has doubled in the past year, a leap in the price of this basic agricultural commodity not seen since 1974 in the first oil price crisis.

 

It has become fashionable to blame rising food prices on new gourmet consumers in China and India, and a series of bad harvests.

 

But oil prices are also very much to blame.

 

In the postwar era the Green Revolution in agriculture has led to a gradual erosion of wheat prices.

 

The exception was a price spike that came in 1974, when wheat – and all other dollar-denominated commodities – reacted to spiralling oil prices and the whole world entered a bear market in stocks and stagflation.

 

The second exception has been over the past year with wheat prices doubling.

 

The transmission mechanism between the oil and wheat price is complex but a good deal of energy is expended in the gathering, transportation and drying of wheat.

 

And speculation in basic commodities only enhances this effect. It is not fair to blame new consumers in China and India for rising agricultural prices.

 

In China inflation is starting to hurt ordinary people in a country where tens of millions still live in poverty and as much of 50 per cent of household income is spent on basic food stuffs.

 

Food, which makes up one third of Chinese consumption, costs 18 per cent more this January than a year ago, after rising 17 per cent in 2007.

 

In fact, consumers are now eating less and not more of expensive foods.
For example, many of China’s 1.3 billion people are avoiding their staple diet of pork because the price has jumped 59 per cent from January a year ago.

 

Oil prices headed above $100-a-barrel again last week: close to an all-time high for black gold.

 

Adjusted for inflation the 1979 $38 peak oil price is the equivalent of paying $104 today.

 

But oil would have to average $104 for the entire month to be as high as the price last seen in December of 1979.

 

The direct relationship between oil and inflation was evident in the 1970s, when the cost of oil rose from a nominal price of $3 before the 1973 oil crisis to $38 in 1979.

 

This helped cause the consumer price index of inflation to more than double from 41.20 in early 1972 to 86.30 by the end of 1980.

 

That is to say it took eight years in the 1970s for prices to double, whereas it had previously taken 24 years to achieve the same change in the CPI.

 

Perhaps the only positive point to remember in this scenario is to recall that commodity prices did fall back sharply.

 

In 1974 the price of wheat plunged back to earth when stock markets crashed and speculators were forced to cash out of commodities.

 

Even oil prices dipped but were back up again by 1979, only to plunge in the early 1980s.

 

There followed the surprising reversal of a 20-year bull market in most commodities and for the next 20 years commodities languished in a bear market.

 

The efficiency bonuses Green Revolution technology and innovation kept the lid on prices until very recently when oil again led commodity prices into inflationary overdrive.

 

Visiting supermarkets in Dubai these days is a reminder of inflationary times of the past.

 

But something always happens to end a period of inflation.

 

In Britain, Margaret Thatcher first caused inflation to spike higher by introducing VAT but then grasped this problem and deflated the economy with a nasty recession.

 

Dr Paul Volcker administered the same medicine for President Ronald Regan.

 

The worrying thing this time around is that most global policy makers currently seem far more concerned about preventing a banking sector meltdown and recession than inflation.

 

Money supply figures are soaring as liquidity is pumped into the global economy and this can only fuel further inflation.

 

Only in Australia are the authorities talking about raising interest rates to dampen inflation.

 

After the Asian Financial Crisis in 1998 the IMF insisted on tight fiscal and monetary policies to correct the imbalances in these economies.

 

But at present the US is doing precisely the reverse in response to its financial crisis, and higher commodity prices therefore seem inevitable in a re-run of the late 1970s.

 

However, consumers in the Gulf generally have high disposable incomes and spend a relatively small amount on groceries.

 

Spare a thought for the poor in other countries who will go short of food because prices are too high.

 

 

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