With droughts and poor harvests in both North America and in Russia and the Ukraine, there are worries that food prices are likely to see sharp rises in the coming months. This is clearly bad news for consumers, especially the poor for whom food accounts for a large proportion of expenditure.
But it’s also bad news more generally, as higher food prices are likely to have a dampening effect on the global economy, struggling to recover from five years of low or negative growth. And it’s not just food prices. Oil prices are rising again. Since mid June, they have risen by nearly 25%. This too is likely to have a dampening effect.
Another contributing factor to rising food prices is a response, in part, to rising oil prices. This is the diversion of land from growing food to growing crops for biofuels.
G20 countries held a conference call on 28 August to discuss food prices. Although representatives decided against an emergency meeting, they agreed to reassess the situation in a few weeks when the size of the US harvest would be clearer. If the situation proved as bad as feared, then the G20 would call an emergency meeting of the Rapid Response Forum, to consider what could be done.
But is the sole cause of rising food prices a lack of production? Are there other problems on the supply side, such as poor distribution systems and waste? And what about the role of demand? How is this contributing to long-term increases in food prices? The articles consider these various factors and what can be done to dampen food prices.
Articles
G20 points to ‘worrying’ food prices Financial Times, Javier Blas (28/8/12)
US food prices to surge on drought Gulf News(30/8/12)
Best to get used to high food and energy prices – they’re here to stay The Telegraph, Jeremy Warner (29/8/12)
Feeling a drought The Economist (14/8/12)
Q&A: World food and fuel prices BBC News (14/8/12)
G20 considers global meeting as food prices rise BBC News (28/8/12)
Biofuels and Food Prices (direct link) BBC ‘In the Balance’ programme (25/8/12)
U.N. body urges G20 action on food prices, waste Reuters, Patrick Lannin (27/8/12)
Ethanol industry hits back over food price claims EurActiv (28/8/12)
The era of cheap food may be over Guardian, Larry Elliott (2/9/12)
Data
Food Price Index Index Mundi
Questions
- Why have food prices been rising in recent weeks?
- Use a demand and supply diagram to demonstrate what has been happening to food prices.
- What determines the price elasticity of demand for wheat? What might this elasticity vary over time?
- What is the role of speculation in determining food prices?
- Illustrate on an aggregate demand and supply diagram the effect of a commodity price shock. What is likely to be the policy response from central banks?
- What determines the price elasticity of supply of food in (a) the short term and (b) the long term?
- What determines the cross price elasticity of supply of food to the price of oil? Is the cross price elasticity of supply positive or negative?
- What can governments do to reduce food prices, or at least reduce food price inflation?
- What benefits may come from higher food and fuel prices over the longer term?
Anyone investing in commodities over the past few weeks will have been in for a bumpy ride. During the first part of 2011, commodity prices have soared (see A perfect storm brewing?). This has fuelled inflation and has caused the Bank of England to revise upwards its forecast for inflation (see Busy doing nothing see also Prospects for Inflation).
But then in the first week of May, commodity prices plumetted. On the 5 May, oil prices fell by 7.9% – their largest daily amount since January 2009. Between 28 April and 6 May silver prices fell from $48.35 per ounce to just over $33.60 per ounce – a fall of over 30%. And it was the same with many other commodities – metals, minerals, agricultural raw materials and foodstuffs.
Many financial institutions, companies and individuals speculate in commodities, hoping to make money buy buying at a low price and selling at a high price. When successful, speculators can make large percentage gains in a short period of time. But they can also lose by getting their predictions wrong. In uncertain times, speculation can be destabilising, exaggerating price rises and falls as speculators ‘jump on the bandwagon’, seeing price changes as signifying a trend. In more stable times, speculation can even out price changes as speculators buy when prices are temporarily low and sell when they are temporarily high.
Times are uncertain at present. Confidence fluctuates over the strength of the world recovery. On days of good economic news, demand for commodities rises as people believe that a growing world economy will drive up the demand for commodities and hence their prices. On days of bad economic news, the price of commodities can fall. The point is that when undertainty is great, commodity prices can fluctuates wildly.
Articles
Commodities plunge: Blip or turning point? BBC News, Laurence Knight (6/5/11)
Commodity hedge fund loses $400m in oil slide Financial Times, Sam Jones (8/5/11)
Commodities: ‘epic rout’ or the new normal? BBC News blogs: Stephanomics, Stephanie Flanders (6/5/11)
Commodities Still a Bubble – But Prices May Continue to Rise Seeking Alpha, ChartProphet (9/5/11)
When a sell-off is good news The Economist, Buttonwood (6/5/11)
Gilt-edged argument The Economist, Buttonwood (28/4/11)
Commodities: What volatility means for your portfolio Reuters blogs: Prism Money (9/5/11)
Gold, silver rise again on debt, inflation concerns Reuters, Frank Tang (10/5/11)
Commodities After The Crash, No Way But Up The Market Oracle, Andrew McKillop (9/5/11)
Outlook 2011:Three Dominant Factors Will Impact Precious Metals in 2011 GoldSeek (9/5/11)
Energy bills set to rise sharply next winter, Centrica warn Guardian, Graeme Wearden (9/5/11)
Dollar triggered commodities ‘flash crash’, not Bin Laden The Telegraph, Garry White, and Rowena Mason (9/5/11)
The outlook for commodity prices Live Mint@The Wall Steet Journal, Manas Chakravarty (11/5/11)
Three ways to play the next commodities bubble Market Watch, Keith Fitz-Gerald (11/5/11)
Data
Commodity Prices Index Mundi
Commodities Financial Times
Commodities BBC Market Data
Questions
- Why did commodity prices fall so dramatically in early May, only to rise again rapidly afterwards?
- Why do commodity prices fluctuate more than house prices?
- What is the relevance of price elasticity of demand and supply in explaining the volatility of commodity prices?
- Under what circumstances is speculation likely to be (a) stabilising; (b) destabilising?
- To what extent are rising commodity prices (a) the cause of and (b) the effect of world inflation?
- If commodity prices go on rising every year, will inflation go on rising? Explain.
As the global recession began to take hold during 2008, so many commodity prices plummeted. Oil prices fell from over $140 per barrel in mid July 2008 to around $35 per barrel by the end of the year (a mere quarter of the price just 6 months previously). From early 2009, however, prices started rising again and have continued to do so during 2010. By mid April 2010, the price of oil had risen to $85 per barrel.
And it’s not just oil prices that have been rising. The prices of metals such as copper, nickel and zinc have been soaring. Since the beginning of February 2010, copper prices have risen by 18%, zinc prices by 20% and nickel prices by 46%. As the article from the Independent states:
The Office for National Statistics said that the input price index for materials and fuels purchased by the manufacturing industry rose 10.1 per cent in the year to March and rose 3.6 per cent between February and March alone. The ONS added that prices of imported materials as a whole, including imported crude oil, rose 4.4 per cent between February and March.
Much of the explanation for this has been the global recovery. But while raw material prices have been rising, grain prices have been relatively steady and recently have fallen. So how can this be explained? The answer, as always with commodity prices, lies with demand and supply, as you will see when you read the following articles.
Articles
Commodity prices fuel inflation spike Independent, Sean O’Grady (10/4/10)
Interest rates may have to rise sooner after figures point to inflation rise Guardian, Katie Allen (9/4/10)
Pound rises as UK producer prices hint at inflation BBC News (9/4/10)
Petrol price hits record high BBC News (8/4/10)
China commodity imports soar despite high costs Reuters (10/4/10)
March Output Price Inflation Highest Since Nov 08 Marketnews.com (9/4/10)
Spring season: What is pushing up the price of copper and other base metals? The Economist (8/4/10)
Factory gate price rise leads to fear of inflation Financial Advice (9/4/10)
Corn Falls as Warm, Dry Weather Will Aid Planting in the U.S. BusinessWeek, Jeff Wilson (8/4/10)
Wheat Futures Fall as U.S. Exports Slump, Global Crop to Gain BusinessWeek, Tony C. Dreibus (9/4/10)
Commodities: Chinese imports defying commodity−price rally for now FZstreet.com, Danske Research Team (12/4/10)
Data
Commodity prices can be found at the following sites:
Commodity price data BBC News: Markets
Commodity prices Index Mundi
World Crude Oil Prices U.S. Energy Information Administration (See, for example, Brent Crude Oil Prices)
UK factory gate prices can be found at:
Latest Producer Prices Office for National Statistics, and
Producer Prices portal Office for National Statistics
Questions
- Use supply and demand analysis to explain why raw material prices have risen so rapidly. Illustrate your answer with a diagram.
- Use supply and demand analysis to explain why grain prices have fallen. Again, illustrate your answer with a diagram.
- What is the significance of income elasticity of demand and price elasticities of demand and supply in explaining the price changes in questions 1 and 2?
- How would you estimate the likely effect of a 1% rise in (a) general raw material prices and (b) factory gate prices on the rate of consumer price inflation?
- Why has the price of petrol risen above the level of July 2008, given that oil prices now are only about 60% of those in 2008?
- Why has a rise in factory gate prices led to a rise in the sterling exchange rate?
- If inflation rises as a result of a rise in commodity prices, what type of inflation would this increase in inflation be? Does the answer depend on what caused the rise in commodity prices?
Until recently, gold prices had been rising. If you watch TV, you can hardly have failed to notice the adverts offering cash back for your gold. After peaking on the 2nd December 2009, however, at about $1220 an ounce, the price of gold fell almost $100 in just four trading days.
Over the past two months, we’ve seen a fluctuating US dollar and a fluctuating price of gold. In the news item ‘A golden age‘ we looked at the factors that led to a rising price of gold and one key factor was the weakness of the dollar. However, the dollar’s downward spiral appears to have halted, at least for the time being.
Figures for US GDP were higher than expected, with increases in economic activity in the 4th quarter of 2009. This may partly explain why the dollar strengthened, and prices of gold began to fall, as people began investing in US assets. And it was not just gold that fell – there was speculation that the price of copper too would fall as investors switched to US assets.
Then, at the end of January the dollar fell against most currencies and a variety of refined products recovered from recent losses incurred. This pause in the demand for the dollar may cause gold prices to increase once again, as traditionally, gold moves inversely to Greenback. Although the price of gold was down 1.1% for the month of January, speculation that the US budget deficit could be as big as $1.6 trillion could mean further support for gold and testing times to come for the dollar.
At the beginning of February 2010, the US dollar weakened against the euro, as investors favoured a return to riskier assets in search of higher returns, encouraged by signs of strengthening manufacturing in key economies. With the global economy coming out of the worst downturn in decades, will the dollar begin to strengthen?
Dollar advances on reduced demand for risk Wall Street Journal (15/1/10)
US dollar on defensive as risk appetite rises Business News (2/2/10)
US dollar on defensive as risk appetite rises Business News (2/2/10)
Why the price of gold is rising BBC News (13/10/09)
Gold trend remains firmly down despite dollar rally confronted by massive US budge deficit The Market Oracle (1/2/10)
Gold may rise for first time in week as dollar spurs demand The China Post (2/2/10)
Dollar and Yen fall as optimism returns Daily Forex Strategy Briefing, Hans Nilsson (2/2/10)
Gold declines for second day, as dollar’s advance curbs demand Bloomberg, Kim Kyoungwha (8/1/10)
Crude ends up as equities rise, dollar slips Reuters (25/1/10)
Copper may decline as stronger dollar saps demand Bloomberg (22/1/10)
Questions
- How is the price of gold determined? Use a diagram to illustrate this process. If there is a change in demand or supply for gold, what factors will affect the extent of the price change?
- Why does a strengthening dollar imply a lower price of gold?
- Why will a large US budget deficit support gold, but test the dollar?
- How is the exchange rate determined? What factors affect the supply of dollars and the demand for dollars?
- What are the main factors that could explain why there has been a rise in the dollar? Could speculation play a role?
Gold prices have been soaring in recent months. In fact, such is the demand for the precious metal that Harrods has just started selling gold bars. “The Knightsbridge department store yesterday began selling bars of pure Swiss gold bullion as part of a range that is being displayed in a miniature vault on the lower ground floor” (see eighth link below).
In November 2008, gold was trading at around $750 per ounce; by October 2009, the price had reached $1080 per ounce. Why has this happened? Will the trend continue? What does it signify about the world economy – both its current and likely future state? The following articles look at the causes and effects of this new ‘golden age’.
Gold prices continue to hit new highs Guardian (7/10/09)
Gold price hits fresh high Guardian (14/10/09)
Gold’s bull run set to roar ahead This is Money (17/10/09)
Why the price of gold is rising BBC News (13/10/09)
Gold price ‘set to double in four years’ (includes video) Telegraph (10/10/09)
Gold at $1,500? Don’t hold your breath Telegraph (10/10/09)
Bullion bulls The Economist (8/10/09)
Harrods put Swiss gold bars up for sale in a miniature vault Times Online (16/10/09)
Gold Eases from New High as “Less Bad” Data Drives Up Equities, Oil & Wall Street Bonuses BullionVault (14/10/09)
Gold Just Broke Its Neck, Targets $5,250? The market Oracle (14/10/09)
Questions
- Use a demand and supply diagram to illustrate the change in the price of gold between November 2008 and October 2009. Does the explanation lie largely of the demand or the supply side? Use the concepts of price elasticity of demand and supply to explain the size of the price change for any given shift in demand or supply.
- How is the price of gold related to the strength of the US dollar?
- Explain whether gold is a commodity or a currency (or both).
- What is meant by the ‘head and shoulders pattern’ in the price of gold? Is the use of ‘patterns’ a good way of predicting future prices? Give reasons why it may or may not be.
With droughts and poor harvests in both North America and in Russia and the Ukraine, there are worries that food prices are likely to see sharp rises in the coming months. This is clearly bad news for consumers, especially the poor for whom food accounts for a large proportion of expenditure.