AGFLATION: Oil, Steel, and Dollar Prices Fall, Food Becomes More Expensive

Food producers have concluded that they have not sufficiently passed on the increase in their own ‘inputs’ to consumers. The conclusion is self-evident: rising prices. Optimistically viewed at two to three percent, while pessimists threaten a double-digit figure – of 10 percent.

Written by: Mladen Car

We, the end consumers, often shake our heads while strolling through supermarkets, hypermarkets, and megastores, looking at the prices of food staples. Amid all the struggles and woes that economists forecast for this year, we only needed more expensive food. As if unemployment and declining standards were not enough. The price tsunami that began rolling through the food market last year has not yet stopped. And it seems it won’t.

When they explained the price increases of bread, milk, and meat in 2007, they pointed fingers at the rising prices of raw materials (corn, wheat). The same was true last summer when oil prices soared. Since that fundamental commodity has significantly decreased in price in the meantime, it seems no longer logical for us to be frightened by new food price increases.

However, the last people in our family trees who went to ‘work’ with a hoe were our (great) grandmothers and (great) grandfathers. They were well acquainted with agricultural laws and mathematics. If they were to be told about the current market situation, they would surely say: ‘Logical.’

The processing of food from the very beginning, from sowing to the finished product on the table, takes a long time, so the symptoms of disruption appear only after several months or even a year. Everything becomes even more complicated if the product is more complex, such as meat. When wheat, soy, and corn prices began to soar last summer, the meat industry had no choice but to buy at those inflated prices. And that was not the end. To protect themselves from even greater shocks and sudden price jumps, raw materials were purchased on commodity exchanges in the form of futures contracts for risk protection. (The price is agreed upon today, and the goods are delivered in three, six, or 12 months.)

The advantage of agreements has now proven to be a big problem. Livestock was already eating expensive raw materials last summer, and today it eats even more expensive ones. Since contractual obligations must be fulfilled, corn and wheat must be paid at the agreed astronomical prices. This domino effect also applies to poultry, as well as dependent products like milk, eggs, and cheese. Summarizing last year, many food producers concluded that they did not sufficiently pass on the increase in their own ‘inputs’ (seed, fertilizer, energy) to consumers. The conclusion is self-evident: rising prices. Optimistically viewed at two to three percent, while pessimists threaten a double-digit figure – of 10 percent.

This negative trend has its roots in the disruption caused in the global balance of supply and demand for food. In 2000, the rapid rise of Asian economies, China and India, began, which together make up 40 percent of the world’s population. As these countries became wealthier, their populations began to change their eating habits, slowly abandoning ‘boring’ foods: rice, potatoes, vegetables. The objects of adoration became pork and beef, which until then had only been a dream for many residents. But here agricultural mathematics comes into play. For one kilogram of meat, each pig must eat three, and cattle even eight kilograms of corn or some other grain.

Therefore, the demand for grains is growing enormously. This trend was quickly recognized four to five years ago when North and South America intensified the production of agricultural crops and ‘satisfied’ the incredible demand from Asia with large shipping shipments.

With increased demand from Asia, America itself contributed to the rise in prices of agro-products. The Washington administration has been looking for decades for a way to break free from dependence on Middle Eastern oil. With technological advancement, the solution was found in ‘agricultural oil’ abundant in the USA – corn. America produces 100 percent more than its domestic needs. Therefore, in 2002, intensive processing began in ethanol refineries (11 percent of total corn produced). In the last two years, even a third of the entire harvest has ended up in car fuel tanks. A similar story applies to soy, as chemists have also managed to adapt it for combustion in diesel engines (biodiesel).

Indirectly, the phrases ‘food security’ and ‘agflation’ (food price increase) have been introduced into the lexicon. The era of cheap agricultural raw materials has ended, which will affect all countries where agriculture exists. It does not matter whether they participate in the biofuel sector or not. If cheaper corn or wheat appears in any country, someone from the global food market will buy it and transfer it to the ‘more expensive’ via cheap shipping.

To make this interesting global card game even more tense, speculative investors have also gotten involved. They have always been present in commodity exchanges, but their influence was not decisive in price formation as they were in the minority. At the beginning of the bursting of the real estate bubble in the USA in August 2007, many predicted a complete disruption in the financial market and suddenly began pulling out money. A place was sought that was not connected to those classes of investment. The answer was simple: food is the safest. The influx of capital into the Chicago exchange was fantastic. In certain agro-raw materials, fresh money was arriving every month in amounts greater than 10 percent. And we are talking about billions of dollars here.

Large food importers (e.g., Japan) swallowed hard when they saw the prices they would have to pay for corn and wheat. The disruption spread capillary to the most hidden corners of the market. Large global beverage traders began to complain because ‘someone unknown’ started buying large quantities of French wines, paying above-average prices. Bottles that were usually sold for five dollars were being bought by this secret buyer for six to seven. It was quickly discovered that some hedge funds were buying wines in an attempt to preserve the value of money in the collapsing global financial market. The estimate was that wine would not lose value but would become more expensive due to artificially induced demand.

And that game came to an end with the end of summer. Many investors received a death call – ‘margin call’ – from their banks, and the sale of large portfolios of raw materials (oil, gas, copper, iron, silver, corn, wheat) began. By the end of the year, prices of agro-raw materials experienced unprecedented corrections, greater than 50 percent. Thus, logic partially returns to the market, and the assessments of agronomists become relevant and listened to again. The media once again quotes weather forecasters and ministers of agriculture instead of commodity brokers from large banks. Unfortunately, the prices of artificial fertilizers did not follow the decline, and they will even increase due to rising gas prices, and the same will happen with the rent of agricultural land. Agriculture has become very attractive to many people as it allows them to be independent entrepreneurs, but there are too many interested parties. These factors further exert pressure on the rise in food prices this year.

Domestic farmers had an excellent year, but once again suffered due to spontaneous production and lack of information. The price of corn and wheat plummeted, leaving many silos and warehouses full. The question is what will happen when harvest time comes again. It smells of tractors blocking the roads.