Food glorious food

Inflation is public enemy number one for us because it picks our pockets by eroding the real value of our bonds. The latest twist to the inflationary story is the rapid rise in food prices, from the staples of wheat to rice (click chart to enlarge).

Normally central banks can dismiss volatile food prices as temporary, because prices are influenced by random effects such as drought and weather patterns. These temporary blips should not cause second round effects (eg higher wages) and therefore shouldn’t enter the inflationary food chain – indeed, the Federal Reserve targets core inflation, which strips out food and energy (see previous blog comment).

However this time around, worrying signs of political interference are resulting in inefficient economic outcomes. The policy response to food shortages in Argentina has been to raise tariffs on exports, meaning that food floods the domestic market and prices stay low. It could be their funeral, as Argentine farmers will likely react by planting less wheat, which drives the price of wheat higher and its supply lower. Shortages will be back soon – Adam Smith would not approve.

Argentina’s policy approach is being replicated by other countries around the world (eg Russia, Ukraine, China, Serbia, Kazakhstan, Egypt, Vietnam, Indonesia, India, Cambodia and Venezuela). This kind of inflationary protectionism is a worry for bond investors, as food price rises will cease to be short term and temporary, and could instead become long term and permanent. Food forms around half of poorer countries’ consumption, and government actions to keep prices down are therefore understandable. But policy markers should be reviewing the situation with regard to the long term implications, rather than do anything for short term popularity.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

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