Wednesday, November 17, 2010

Agflation and the Cross of Gold


Some things never change. American and European history remain "deep," that is dominated by long cycles of debate over fundamental questions, that are never really resolved one way or another. The desire for elites (mostly but not exclusively in the East) for cheap labor and expensive land, and Jacksonian type Westerners (think Sarah Palin and the Tea Party) for expensive labor (their own) and cheap land remains one of these deep cycles. The Federal Reserve's decision to buy back $600 billion of Treasury Bonds, and achieve another $300 billion of repurchases through re-investment of maturing securities, and the resulting inflation of agricultural products, at least in part, is another. Meaning the debate between the Free Silverites, and the Gold advocates, is not over. Just flipped, entirely.

Now of course the Fed is not solely responsible for the inflation of agricultural commodities. As the Financial Times has reported, much of this is due to intense Chinese demand and tight global supply in the face of this increased demand. China has a voracious appetite for cotton, which it turns into cheap clothing exported mostly to the US, various base metals including iron, copper, lead, and tin (propping up the economies of Australia, Chile, Brazil, South Africa, and other commodity exporters) which it turns into various auto parts, cheap electronics, and other consumer goods for the US export market. A rising demand for food, and in particular, more protein, has led to a demand not just for beef and pork imports, but food-stocks including corn, soybeans, and wheat. Meanwhile, floods in Pakistan have destroyed the current harvest, and Pakistan is a major exporter of cotton. Droughts and fires in Russia have led to a ban on exports of grain, and Russia is a major grain exporter. Uncertain harvests in India have led to bans on sugar exports, with uncertain harvests in Brazil leading to very high sugar prices.

As the Financial Times noted:

The spectre of inflation loomed over agricultural markets after the US slashed key crop forecasts and warned of shortfalls in grains.

The agriculture department on Tuesday cut estimates of US corn yields for a third successive month, forecast record soyabean exports to China and warned of the slimmest cotton stocks since 1925.

“The combined production shortfalls and dramatic potential stock drawdowns mean a much tighter supply picture than just a few months ago,” the agency said in a separate grains report.

Benchmark Chicago corn futures soared above $6 a bushel for the first time since August 2008, before ending lower. Soyabeans rose 4.3 per cent and New York cotton futures posted a record above $1.51 a pound. The price rises have revived fears of a repeat of the global food crisis of 2007-08.


Drudge has a link to a Financial Times story on global food inflation here.

The bill for global food imports will top $1,000bn this year for the second time ever, putting the world “dangerously close” to a new food crisis, the United Nations said.

The warning by the UN’s Food and Agriculture Organisation adds to fears about rising inflation in emerging countries from China to India. “Prices are dangerously close to the levels of 2007-08,” said Abdolreza Abbassian, an economist at the FAO.

The FAO painted a worrying outlook in its twice-yearly Food Outlook on Wednesday, warning that the world should “be prepared” for even higher prices next year. It said it was crucial for farmers to “expand substantially” production, particularly of corn and wheat in 2011-12 to meet expected demand and rebuild world reserves.

But the FAO said the production response may be limited as rising food prices had made other crops, from sugar to soyabean and cotton, attractive to grow.

“This could limit individual crop production responses to levels that would be insufficient to alleviate market tightness. Against this backdrop, consumers may have little choice but to pay higher prices for their food,” it said.

Sell-offs at the height of prices last week lowered prices a bit, but structurally the imbalance between demand (high) and supply (low) have led to gains, with March 2011 futures prices still strong, indeed higher in many cases than spot prices. Meaning inflation in food prices is here to stay, at least for the moment. And not just food either, cotton prices have soared to record heights, and oil is trading at about $90 a barrel. Food price inflation in China is reported at 8% annualized rates, with lower rates in the US at 1.4% over the last 12 months. In both cases the real rate of inflation is likely undercounted.

Anyone who has shopped for food regularly in the past year knows that prices have risen appreciably. First, in packaging reduced amounts of food for the price charged in prior years for larger amounts. And secondly, in outright price rises simply not counted by US economists. The things people buy, nearly every day, gasoline, milk, eggs, butter, bread, have all risen steadily over the past year. It is true that prices for cheap Chinese sneakers or electronics have remained steady, but that is not something people buy every day. The ordinary person's experience with inflation (at a time of lowered wages and massive job losses and unemployment) is remarkable as the elite's disconnect from this reality.

And while increased Chinese demand amidst tight global supply of commodities is part of the story, so is the struggle between the Free Silverites and the Gold Advocates.

In 1896 during the Democratic National Convention, William Jennings Bryan, the man pictured at the top of this column, gave the famous "Cross of Gold" speech. He said, "Having behind us the producing masses of this nation and the world, supported by the commercial interests, the laboring interests and the toilers everywhere, we will answer their demand for a gold standard by saying to them: You shall not press down upon the brow of labor this crown of thorns, you shall not crucify mankind upon a cross of gold."

Bryan's political base was that of small farmers in the West. Who had debts they wanted to inflate away. Free Silver, or more properly, loose monetary policy designed to create inflation, would allow the farmers to inflate away their debts to nothing. That would of course destroy the Eastern Financiers, with extensive cash holdings, as well as Eastern laborers who paid cash for consumer goods and food. Bryan's base was demographically too small, as the small farmers were just too few in number to make a difference. Strong monetary policy prevailed, arguably until the 1971 decision by Richard Nixon to end the Bretton Woods agreement of 1944.

From then onwards, various Presidents have had more or less inflationary policy, to cover systemic deficits, but the core of US policy has been a free-floating dollar and inflationary monetary policy. From Reagan through Bush, including Clinton, the policy has been to have inflation around 2-4%, on the theory that this level of inflation would not inflame US consumers but mark an expanding economy. Call it the Goldilocks theory of inflation. Just right.

"Helicopter Ben" Bernanke, Chairmen of the Federal Reserve, noted:

In 2002, when the word "deflation" began appearing in the business news, Bernanke gave a speech about deflation. In that speech, he mentioned that the government in a fiat money system owns the physical means of creating money. Control of the means of production for money implies that the government can always avoid deflation by simply issuing more money. He said "The U.S. government has a technology, called a printing press (or today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at no cost." (He referred to a statement made by Milton Friedman about using a "helicopter drop" of money into the economy to fight deflation.) Bernanke's critics have since referred to him as "Helicopter Ben" or to his "helicopter printing press." In a footnote to his speech, Bernanke noted that "people know that inflation erodes the real value of the government's debt and, therefore, that it is in the interest of the government to create some inflation."For example, while Greenspan publicly supported President Clinton's deficit reduction plan and the Bush tax cuts, Bernanke, when questioned about taxation policy, said that it was none of his business, his exclusive remit being monetary policy, and said that fiscal policy and wider society related issues were what politicians were for and got elected for. But Bernanke has been identified by the Wall Street Journal and a close colleague as a "libertarian-Republican" in the mold of Alan Greenspan. However, Bloomberg News writes he is "siding with John Maynard Keynes against Milton Friedman by flooding the financial system with money".

Suspicion is high that Bernanke, following Obama's marching orders, is determined to inflate away the Government debt, and also create high inflation to "force" companies with large cash reserves (which describes most large companies) to invest them to create economic growth rather than see their cash values decline in inflation. Bernanke in various public statements defending the Fed's purchase of $600 billion of US Treasury bonds, and the additional $300 billion re-investment in the same, by simply declaring the new money "created" has argued explicitly that inflation must be higher to force re-investment by major companies.

In other words, the most stupid policy one could imagine, is what the Federal Reserve (and Obama) are following. And it is the same debate over monetary policy that characterized most of the 19th Century, only reversed completely. [Astute observers will note that cheap dollars are merely serving to allow multinational corporations to invest in China and Vietnam and other places, taking US tax dollars to create jobs overseas where interest rates and returns are greater and labor is cheaper. Bernanke's and Krugman's and Obama's 1930's Depression models don't take into account US companies investing in China and other cheap labor places. FDR did not have to deal with Ford and GM and US Steel investing in China to earn more money than in the US.]

Now the loose monetary policy advocates are not relatively powerless small farmers, but East Coast and West Coast elites, with globally mobile investments, mostly sitting in government or the media or the universities, seeking to create inflation to preserve social spending (on their favorite hobby horses) and put away for another day a fiscal reckoning on the budget and spending. Those pursuing a strong currency are people who must buy the necessities of living every day, and do so on a limited budget.

On the one hand you have Obama, and Bernanke, and much of Wall Street, wanting high inflation to pump up stock prices, or commodity investments (which Wall Street makes a tidy profit on), and inflate away the government debt so that spending can continue, and on the other hand ordinary people who want to pay smaller amounts not larger ones of their earnings (which are not inflated) for daily living.

Deflation has been a feature of Japanese life since the end of the asset bubble (real estate) bursting in 1989. For most Japanese consumers, deflation has been tolerable, despite low or no economic growth, because their money goes much further. Inflation particularly linked to low or no economic growth (1970's stagflation) means a constantly eroding standard of living for ordinary people. While deflation means those with jobs at least, pay less every day not more for daily living.

Thus Obama's and Bernanke's objectives (and that of their Wall Street allies who donated heavily to Obama) are directly opposite that of ordinary people's. Who now, contra Bryan, want a cross of Gold. To protect them from inflation. The ads that run on shows like Glen Beck's on Fox News Channel, hit a populist chord with his viewers. Because they fear inflation as a mortal threat to their lives. Which it in fact is, and remains.

So what can be done to improve people's lives? Simple. Dump Helicopter Ben (Friedman's speech alluded to dumping money out of a helicopter to "save" the economy) and adopt a sound monetary system. Gold-backed dollars are probably out of the question, as there simply is not enough gold in US reserves or global reserves to back the dollar. But silver is another question. A silver backed currency, redeemable at a fixed rate, would force the US dollar into a strong rather than weak currency. This would hurt of course, US manufactured exports. But the exports themselves are a small portion of US manufacturing, itself only about 10% of all US jobs.

A strong dollar also means cheaper imported oil, and thus lower costs for daily living. Cheaper gas! A strong dollar can also promote more production domestically of grains and other food stocks, and cotton as well. Tariffs would have to be raised to keep US manufacturing from being flooded by cheaper foreign goods, but that is something that is far easier when US dollars buy much more food and gas than when it buys almost nothing. Certainly the experience of Argentina, which like Russia has used bans on wheat exports, has not been positive. The short term protection of prices in the local markets meant farmers stopped growing wheat and switched to soybeans, not subject to export bans. A strong dollar allows US consumers to outbid weak Chinese or other currencies, for the same bushel of wheat, and allows farmers to make money by planting more wheat.

A strong dollar also allows from a policy that is critical: US creation of currently imported foodstuffs internally. Some predict that Chocolate will be as expensive as Caviar in twenty years:

Chocolate industry experts say that in just 20 years, chocolate will be as expensive as caviar, Anthea Gerrie reports for the Independent. African farmers, who produce a huge chunk of the world's chocolate supply, are abandoning their farms because the work is so backbreaking and the pay so miserable. Their children are leaving for the city where they can life a better life.

Meanwhile, demand for chocolate is rising sharply as the Chinese and Indians develop Western a sweet tooth. "The biggest hope," Gerrie reports, "is a Nestlé project to replant 10 million trees over the next decade." But that will replace just a quarter of the trees lost in recent years. By 2030, we may face a depleted, miserable world in which only the rich can afford a chocolatey snack.

Cocoa of course, was native to Mexico. There is no reason that with a strong dollar, US farmers in parts of Texas, Louisiana, Alabama, Mississippi, Florida, Georgia, and even South Carolina cannot grow Cocoa trees. And harvest them with mechanical harvesting machines, the way many orange and grapefruit trees are done now. Does cocoa need to be grown in chaotic, violent, and poverty-stricken Ivory Coast, or in the US in subtropical regions (Puerto Rico and Guam are also good candidates) with the latest equipment substituting for cheap labor?

Coffee too, can be grown in the US. Hawaii currently exports premium coffee, but the plant itself is native to Ethiopia and Yemen. Meaning varieties can be grown in places like Southern California, or Arizona, or New Mexico, or Texas, or Louisiana, or Alabama, or Mississippi, or Florida, or Georgia, or South Carolina. As well again, as Puerto Rico and Guam.

Starbucks is opening its first ever coffee plantation in China, why not ones in the US employing a few people with labor-saving farming/harvesting techniques? Hawaiian growers are using coffee plants on trellises, to harvest the plants the way automated harvesters do grape vines in New Zealand, Australia, and some California vineyards. Some California growers are already experimenting with growing coffee this way, in California.

Certainly the government can play a small role, in providing credit and assistance. But private industry, taking advantage of strong domestic demand, and a more robust dollar, would be the model for growing US coffee and chocolate. The way California restarted its wine industry after prohibition, to become one of the dominant regions in the world. All of which is good for ordinary Americans.

The main feature of globalization is that cheap stuff comes with risks. Risks to supply, as shocks around the world are connected directly to ordinary Americans (and vice-versa). A "seat-belt approach" is needed along with global air bags of trade deals and the like. Meaning strong domestic supplies of key commodities and resources currently imported. From rare earths (currently not mined in the US due to environmental concerns and cheap Chinese competition) to coffee and chocolate, and particularly food and gas, the global system as configured is not working for most ordinary Americans. America has no power to change the global system, so it must create its own seat-belt to mitigate shocks from the global system of trade.

Fundamentally, a nation's economic and monetary system (which are mere reflections of each other) should be arranged to benefit ordinary people, not the rich and powerful (in concert with preferred poor people). A strong dollar, "the Dollar of our Daddies" provides the best means for ordinary people to play within the rules (save lots, work hard, spend wisely) and have a happy life. One less filled with anxiety because a Russian grain harvest failed, or a flood in Pakistan killed the cotton harvest. A strong dollar hurts stock prices, and commodity investors, but who cares? They are rich and powerful and can look after themselves. A strong dollar means a fiscal reckoning, well now, and programs like ObamaCare and others being junked as unaffordable (No Child Left Behind, Ethanol, "Green" subsidies, Fannie/Freddie, being prime candidates).

Will this require an all-out political battle against the powerful elites in the legal system, the media, the universities, and government? Assuredly. Can it be won? Yes, if put plainly: a strong dollar benefits ordinary people by reducing the price increases in daily life, and hurts Wall Street and the current elites.

It is simple as that.


Anonymous said...

Cacao is cultivated in tropical Mexico, which is never subjected to the cold spells that even southernmost Florida and Texas commonly experience. Gardeners in these areas will grow Cacao as an ornamental, but they bring their plants inside during the winter. And during the summers they fret over the leaves burning during hot dry periods that the humid tropics don't experience.

madmax said...

Educate yourself. Or at least start the process. Your protectionist economic commentary is embarrassing:

Whiskey said...

I would assume American farmers would have to hybridize the plants the way US winemakers did grape vines, subject to New World funguses absent in the Old World (why Jefferson could not grow the vineyard he tried to create).

As for protectionism, yes it produces economic inefficiency. But Mises never addresses what happens with a massive global cheater, a Mercantilist China. As a matter of policy, the US grew quite well with very protectionist policies, from the founding of the nation up until the 1940's. Without protectionism, as a practical matter, the US will remain poor.

Because the Chinese will obliterate US industry, what remains, by cheap labor and pollution/safety standards, and US services are already over-priced in comparison to cheap well, everyone in India and China.

Mises never dealt with cheap labor halfway around the world being competitive via services as well as goods, via the internet.

Chief Seattle said...

Whiskey is dead on about automating the cocoa harvest and breeding plants that can grow farther north. There's probably techniques and varieties sitting in a university lab right now, ready to go if the near-slave-labor in third world hellholes ever finds an alternative.

A weak dollar is the fairest and most politically acceptable way to sell protectionism right now. It would be better for the country to slap a big tariff on countries like China until they balance their trade. But that's not going to happen, so the next best thing is a weak dollar - imports get more expensive, exports grow, and the working poor will find that the increased jobs more than make up for the increase in the cost of essentials. Of course the non-investor class retirees will lose big in this scenario.

Whiskey said...

The problem Chief Seattle, is that while exports do get more cheap and imports more expensive, jobs tend to shift instead to greater returns, that is the Chinese Market.

In order to invest in China, firms must first create jobs in China, and secondly share technology (to enable native Chinese champions). This has been the experience from GE to Coca-Cola. The likely outcome of cheap dollars is stagflation and agflation (the latter already happening) with wages depressed by China.

Why open a factory here, when China can always lower the export price (by its own competitive devaluation)?

deminohio said...

I think the popular right is pretty tough on fiat currency/fractional reserve banking considering that it's the system we've had in place since the Great Depression, during which time our society has become arguably the richest in human history, with the greatest material abundance for the greatest number than any civilization hitherto extant.

On Protectionism: I'm likewise amazed at the failure of both the modern right and left to acknowledge that this country was built on protectionism, a system known as the "American System," dating all the way back to Alexander Hamilton. The idea that protectionism is always and everywhere undesirable is nothing more than a meme propagated by those with a faint memory and no understanding of a certain Ricardo somebody from undergraduate economics. Ricardo's theory of comparative advantage fails to account for modern conditions of mobile capital and excess capacity, under which, as a practical matter, everything gets made in China, nothing in America.

Paul said...

Read "The Image : A Guide to Peudo-events in America" by Daniel Boorstin . It is an eye opener and applicable today as it was when it came out in the early 1960s.

sestamibi said...

"Gold-backed dollars are probably out of the question, as there simply is not enough gold in US reserves or global reserves to back the dollar."

That makes no sense. There's no need to issue currency denominated in "dollars", an arbitrary standard, after all. Currency can be backed by gold regardless of the total amount on reserve simply by issuing certificates worth one gram, multiples, or fractions thereof for the total stock in reserve.

As for chocolate, it's always reassuring to know that the good folks at Mars, Hershey, and Nestle are so far-sighted: