Food summit overlooks price-surge ingredient
By Hossein Askari and Noureddine Krichene
The summit on soaring food prices convened by the United Nations' Food and
Agriculture Organization (FAO) in Rome on June 4-5 concluded with a
wide-ranging declaration demanding international support and action - while
failing to address a root cause behind the price surge.
The declaration called on the international community to increase assistance to
developing countries, in particular the least-developed countries and those
that are most adversely affected by high food prices, increase investment in
agriculture, provide balance of payments support and/or budget support to
food-importing, low-income countries, and to provide more funding needed for UN
agencies to expand assistance.
The declaration also called for increasing the resilience of world's
food systems to climate change, more dialogue on biofuels and their relation to
food security, and for liberalizing international trade in agriculture by
reducing trade barriers and market distorting policies.
While these recommendations are laudable, the declaration did not addressed one
of the root causes for explosive food prices, a purely monetary cause, and did
not lay out an immediate action plan for the short-run stabilization of food
prices.
Recalling that a loaf of bread cost 7 billion marks in Germany in 1923, it
would not have hurt to ask German farmers at that time to increase food
production, but obviously that was not the proper solution to slow accelerating
food prices, and German farmers would have had no incentive to increase
production in a hyperinflationary economy.
The historical lesson is that high inflation reduces supply. A general price
increase, as opposed to the price increase of a single commodity, is by
definition inflation and a monetary phenomenon. When and if a general price
increase is sustained, it implies that money supply has become highly
expansionary.
Recently, in an enlightened analysis in Liberation, Joseph Stiglitz attributed
the oil and food crises to the ongoing wars in the Middle East and the subprime
meltdown, and to the monetization of their financing. The monetary aspect of
explosive energy and food prices can be readily related to the aggressive
re-inflationary policy of the US Federal Reserve since August 2007, igniting
oil prices from US$65 per barrel to $139 per barrel and food prices to riot
levels, causing a sharp depreciation of the dollar, and ominously creating
strong inflationary expectations.
The soaring oil and food prices are simply the tax burden imposed by the Fed's
massive bailout of Wall Street investment banks and mortgage lenders. As the
Fed creates money to buy bad mortgages and other worthless securities held by
banks and brokerage firms, the value of the savings and wages of everyone on
Main Street will continue to fall. Moreover, the various housing bills and
stimulus packages now passing through Congress will significantly add to the
eventual staggering price tag.
The cost, in the form of accelerating energy and food prices, will be borne by
ordinary citizens throughout the world. Had the Fed not succumbed to political
pressures and followed prudent monetary policies, oil and food prices would
have remained relatively stable. By ignoring the contributions of monetary
policy to the food crisis at the summit, and with the monetary brake removed,
oil and food prices will continue to race to dangerously higher and higher
levels, with attendant recessionary effects and aggravation of malnutrition on
the global level.
Money matters - a lot
Economist and French presidential advisor Jacques Rueff, in his book the Age of
Inflation (1964), argued that money matters to the point that it can
threaten political stability and even civilization. He noted that exceptionally
expansionary monetary policy in the US and United Kingdom, through very low
interest rates, brought a powerful economic boom in 1927-1929 and ended in a
credit crisis and the Great Depression. He showed that a small village could be
pushed into famine by creating purchasing power through credit that is not
matched by an equivalent supply. Within a few years, the small village will
have exhausted its savings capacity and would collapse into starvation.
The same image, he contended, applies to the world economy. The result of
economic mismanagement, budgetary deficits, war spending and loose monetary
policies is inflation, which is the single-worst economic disaster that can
afflict a nation or the world economy. Rueff forcefully argued that inflation
encourages a quandary and penalizes savings and investment. He emphasized that
monetary equilibrium can be maintained only when purchasing power is equal to
the value of wealth and no excess liquidities develop in the economy. Excess
liquidities will translate immediately into rising prices. His main prophecy
was that the world economy would be doomed to succumb into inflationary
disorders as long as sound monetary policies were not established.
Rueff emphasized the role of the price mechanism in achieving economic
efficiency. The setting of interest rates by central banks is a form of price
control and in turn causes serious distortions in the economy. Interest rate
control, while not feasible under the gold standard, has been criticized by a
number of notable economists, including Milton Friedman. Fixing interest rates
can force the real market interest rate below the natural interest rate,
creating an unlimited demand for loans and igniting a cumulative inflationary
process.
By forcing nominal interest rates to low levels and real interest rates to a
negative range in a bid to create a new speculative housing boom (echoing the
style of former Fed chairman Alan Greenspan), the Ben Bernanke Fed is
distorting the price mechanism and preventing recession from running its
natural course. Given low yields on bonds, and fearing a collapse in the price
of bonds, investors have become attracted towards commodity and currency
speculation.
Moreover, because of low interest rates, the cost of speculating and holding
positions in the futures markets has become low while the yields are high. As
interest-rate control translates into accelerating oil and food prices, the
real economy will be continuously depressed. Subsequently, the US unemployment
rate rose to 5.5% in May 2008, and under a combination of the accelerator and
multiplier effects, the economy will go deeper into recession in the coming
months. While Bernanke's theory of restoring a housing boom in the midst of
millions of home foreclosures is a novelty worthy of a Nobel Prize, so far
aggressive money expansion has been followed by further collapse of housing
prices. Eventually, the turning point in housing prices will be reached when
economic desolation spreads and hyperinflation prevails.
The gravity of the deteriorating energy and food markets should have called for
intense preparation for the world food summit, based on appropriate diagnosis
of the recent world macroeconomic stance with the aim of formulating
appropriate policies for stabilizing oil and food prices. Besides unstable
exchange rates, such a macroeconomic stance is characterized by very low
interest rates in comparison with interest rates during the 1975-1982
stagflationary period.
A simple comparison shows how low interest rates are today compared with rates
in 1980 and how far today's rates have to rise before we can hope to rein in
inflationary forces. In this respect, the federal funds rate is 2% now compared
with 19% in 1980. In Japan, the money market rate is 0.33% against 12.7% in
1980. In the UK, the money market rate is 5% compared with 17% in 1980. The
six-month Libor rate (the London Interbank Offered Rate, the basis for
inter-bank lending) stands at 2.7%, down from19% in 1980.
These pervasive low rates are causing money supply to increase at two-digit
rates and are contributing to the fast expansion of domestic and international
borrowing. Excess liquidities are building up with international reserves
(International Monetary Fund data) rising to $6,391 billion in 2007 from
US$1,936 billion in 2000, indicating an immense explosion of global purchasing
power that will keep oil and food markets under rising pressure.
The food summit should have recognized that removal of the money brake is
pushing the world economy to the brink of economic and financial disorder. The
longer we delay in arresting money growth, the more ominous the economic
collapse will likely be.
The specter of hoarding, rationing and trade restrictions (as some countries
continue their food export ban even after the summit in Rome) could not be
disregarded. There will be little hope that oil and food producers will invest
to increase output when the dollar has become so depreciated.
Surrendering real commodities against a depreciating dollar is not yet an
acceptable trade. In the wake of the FAO summit, the UN body should call an
urgent conference for arresting money disorder and pass a resolution calling on
major central banks to adopt procedures similar to those followed during
1979-1982, consisting of controlling monetary aggregates instead of interest
rates.
If the money brake were re-introduced, then supply-side policies would be
meaningful. Otherwise, maintaining the status quo does not bode well for world
economic stability and enhanced food and energy supplies.
Hossein Askari is professor of international business and international
affairs at George Washington University. Noureddine Krichene is an
economist at the International Monetary Fund and a former advisor, Islamic
Development Bank, Jeddah.
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