“Grains Gone Wild”

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Paul Krugman writes in this article that there is a world food shortage, accompanied by skyrocketing prices. Because of this, poor people in Africa and other places are starving. He suggests that this has come about mostly because of:

• New food demand by China
• The high price of oil
• Bad weather in important farming areas(particularly Australia)
• The reduction of farmland available to grow foodstuff (in favor of growingbiofuelcrops, for the purposes of alternative, (reputedly) environmentally safe energy sources such as ethanol)

Krugman’s proposed solution to these problems is for us to give more of our money to government, so that it can solve the problem the market is apparently incapable of solving.

And now, the REAL story:

Regardless of whether one thinks the above-listed factors play a role in world food shortages, there are in fact two issues of primary importance related to food shortages and food costs that Krugman does not mention, and may not know.

First, the underlying cause of any shortage is the lack of a free market, since genuine shortages cannot appear in a free market. Instead, while prices of goods would likely rise at the onset of reduced supplies, the goods in question would always be available at some price –and the higher the price, the more the supply would increase to meet demand, which would then of course reduce the price. If we had free world markets, food would be exported from some countries, such as the U.S. and Europe, where food is plentiful, to countries where it is needed. This is because it would be profitable to ship goods to needy areas like Africa, where shortages were making prices rise.

The fact that this is not currently happening can be a result only of government price controls (that prevent prices from rising in needy countries), trade restrictions, or some other government barrier which prevents people from getting what they need. The World Bank has cited a list of 21 countries which have price controls on basic staples. We all remember the stories of people in Ethiopia starving in the 1980s, when 3 million people went hungry. What was unreported was that there were 60 million people in Ethiopia at the same time who were unaffected by famine. The moving of food from one part of the country, where it was plentiful, to the other part, affected by drought, was prevented by fighting between the government and rebel groups near the area of the drought. Economic incentives were prohibited by the government’s forced withholding of food shipments (so that rebel soldiers would not have access to supplies), by price controls, by the declaring of grain wholesaling illegal in much of the country, and by the prohibition of the private selling of farm produce or machinery. A similar situation occurred in Zimbabwe in the early 2000s. Indian economist Amartya Sen won a Nobel Prize for demonstrating that most famines are caused not by lack of food but by governments’ ill-advised intrusions into the functioning of markets.

The second issue Krugman fails to mention is that high food prices are a manifestation of current world-wide price inflation. World governments have been printing money at very high rates this decade. While the U.S. has been expanding the money supply by “only” about 10% - 15% per year, many countries have printed money at rates exceeding 50% per year. This money, which had been previously contained mostly in world stock markets, has now also spread to commodity markets, whence the prices of food are derived. Since money is now being created faster than goods are being created, prices are rising.

As another example of this phenomenon of the increase of money exceeding the increase in supply of goods, we may cite the rise in oil prices. Although this has been attributed in the press and other public forums to speculation, greedy oil companies, and increased demands of oil from China, the real cause is the increasing disparity between available money and available oil. Along this same line, the steep rise in prices - of housing, stocks & bonds, oil, gold, commodities, food prices, etc. that we have seen this decade- would be mathematically impossible without the increased supply of money circulating in the world economy. In fact, if the supply of goods were increasing, as it has been, and if at the same time the quantity of money remained stable, prices would necessarily fall.

Make no mistake: for various fundamental reasons related to production, supply, and demand, there is a lack of supply of some commodities available relative to the growing real demand for them. Still, this lack of supply is not the root cause either of the occurrence of shortages or of the extreme increase in world food prices (by over 80% in three years). Additionally, though many commodities such as wheat have been stagnant or in reduced production over the last several years, other commodities have seen continued increases in production; other food groups such as cereals, fruits, livestock, and fish/seafood products have seen mostly increased supply. Data from The Food and Agriculture Organization of the United Nations show that both agriculture production and food production per capita has risen since 1990, and stayed steady since 2000[1]. In comparison, commodities prices have been rising since 1999.

Returning now to Krugman’s piece, we can see that the reasons he adduces for the food shortages and rising prices are illogical. For example, “new demand” for food from China would necessarily have resulted not only in the Chinese themselves producing more food to meet this demand, but in the rest of the world doing so as well. (In fact, China has increased agricultural production per capita by 22% since 2000.) Can we really imagine that world food producers would not have spotted this demand and tried to make profits by satisfying it? They have, and have therefore been producing more food. The Chinese population is increasing by just over one-half of one percent per year. How, then, could the Chinese suddenly have a desire and need for 30% or so more food per year in recent years? Further: how could they pay for it, even if they had the want of more food?

As a concept, “demand” is liable to misunderstanding because we use the term in several different ways. I might have a demand (desire) for a house in the south of France in order to have a place to park the yacht I also demand (desire). In this case “demand” is without consequence, because I do not have the means with which actually to pay for these items. Real demand can affect prices only if there is real purchasing power, in the form of money, to support the demand. Chinese consumers cannot demand, and thus pay for, increased consumption of food without more money, which can only arrive in their pockets after being printed by their central bank. They can have an increased real demand by way of producing more goods with which to pay for more food, but this would serve to reduce prices, not raise them.

To be clear: it is not the companies that people work for which are producing the money, as companies don’t produce money which they pay out as wages — they produce only goods. For companies to have more money (i.e., sell their goods at a higher price than last year) and then pay out more money in wages to workers, more money has to be created by their government in the form of credit expansion.

With regard to China, then: if there were as much of a new demand for food in China as Krugman claims-given a constant amount of money in the economy, there would necessarily be a corresponding reduction in the demand and prices of other goods. Therefore, the Chinese may well be consuming more food, but this increased consumption would not responsible for (absolute) higher prices or shortages.

What, then, about the bad weather? Bad weather could well play a role in the short run. But In the longer run, if Australia has bad weather, even for five years straight, other countries could and would step up their production and increase supply. As an example, more land in the U.S. would be turned to farming. Food shortages in one country would cause world prices to rise by some degree temporarily; but the result in a situation of free trade would be increased production in and increased supply from other countries, a result that would then push the price back down. It’s possible that the lack of free markets has prevented this from happening, but it’s certain that free supply and demand would preclude the possibility of global emergency.

If there were bad weather in most regions of the world at the very same time, the supply of food would in fact decline and prices would rise. But in a free market shortages would still not appear. And in a world of an unchanging supply of money, this effect would be temporary, as prices would fall when supply later increased. Again, as the price of food rose, the price of other goods would have to fall. Sustained price rises among all goods can result only from new money entering the (world) economy.[2]

As for Krugman’s last argument, that farmland usable for food is now being used for the growing of biofuel feedstock instead, this is a question mark. In a free market, if there were a shortage of food and if the (necessarily) associated high prices of food gave that market signal, land used for any other item - biofuel feedstock, car lots, movie theatres, houses, or whatever - would be converted to use for farming.

If we had sustained food shortages in the United States, for example, this is what would happen. Indeed, agriculture used to represent 50% of GDP at the beginning of last century, but is now less than 1%. Land use has changed to meet changing demands. But if we needed food, we could and would build agriculture back up towards that 50% level. On a world-wide scale, as food prices rose, land would be turned to the more profitable growing of food instead of the less profitable growing of biofuel feedstock.

Only if government subsidies were high enough to obscure these market signals, or if government required energy companies to purchase feedstock (which this author is told is the case in the U.S.), could the agriculture production structure be deformed so that this market response would not take place. Similarly, if agricultural lands became difficult to develop due to government regulations to, e.g., protect current farmers, increased production could become difficult.

In sum, the real cause of continually rising food prices is the printing of money by world governments. And the real cause of actual food shortages is the prevention of profitable global trade in food by the ill-advised policies of governments of the very people who are starving. To the extent that any other reasons proposed contribute to a reduced supply more than temporarily, it likely must be because governments prevent the market from working. To ignore these primary drivers of current world food shortages is either willfully to dismiss economic logic, or to be unaware of it.

[2] It could be argued that the observation of food prices rising faster than other goods reveals this very occurrence in our world of changing quantity of money, i.e., that this reflects relative price differences. This relative price difference effect is probably there, but this author would argue that it would explain only a small portion of the relative price difference. The effect of a credit boom being channeled into the commodities markets in general is likely the overwhelming effect of the relative price differences. To say that it explains most or all of the difference, it would require an explanation as to how stock prices, housing prices, and the like can rise so disproportionately more than other normal goods due to a reduced supply, when in fact they have risen while their supply has been in abundance. In other words, it happens all the time in other areas where supply is not limited.

Kel Kelly @ April 19, 2008