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     Jun 11, 2008
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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