A recipe for inflation

As the price of spring wheat soars on the American exchanges, the global phenomenon of 'agflation' appears to be intensifying. By Sean O'Grady

In Pakistan, the prohibitive price of tea became an election issue; the Chinese Communist Party's politburo frets about how long it may be before its poor can afford to eat pork again; Mexican housewives have rioted to protest the shortage of affordable tortilla; Swaziland is facing famine, even as it exports cassava to feed the rich world's hunger for biofuel.

Rising agricultural inflation, or "agflation", is a global phenomenon that touches everyone, and almost every day it seems to intensify. This week, the price of prime spring wheat rose by 25 per cent on the American exchanges, while Russia and Kazakhstan announced fresh curbs on exports to protect domestic supplies. On the Chicago Board of Trade, the price of wheat has hit record highs of more than $12 a bushel. Since 2004 world food prices have doubled, and over the past year alone agricultural prices are up by about 50 per cent.

For those in the developing world who spend their money on food and little else, this is a matter of life and death. The United Nations' Food and Agriculture Organisation says the rising price of cereals such as wheat and maize are a "major global concern".

In the West, the damage caused by increases in the price of food is damped by the costs of transporting and refining it into finished products, and by the general prosperity of consumers. Hard-pressed British farmers even regard current trends as a bonus. The large supermarket chains and food processors are also doing their best to resist the great food inflation. But agflation is making the lives of policy makers more difficult and is hitting household budgets.

Yesterday's "producer price" figures in the United States confirmed the clear inflationary problem faced in factories and food processing plants – a leading indicator of what will soon be seen in the shops. Over the past 12 months, producer prices rose 7.4 percent, the fastest pace since October 1981. Food prices climbed 1.7 per cent, the most since October 2004. Crude food prices – that is, the input costs faced by US suppliers – increased 2.7 per cent. The equivalent figures in the UK reported recently were even more alarming: food prices up 8.5 per cent and input food costs up by between 14.9 per cent (imports) and 36 per cent (home grown) on the year.

Commodity price increases tend to feed on themselves, if that's an appropriate expression. Oil-price hikes raise the cost of hauling crops from continent to continent, especially some of the higher-end "cash crops" the West has developed a taste for; mange-tout flown in from east Africa is bound to become more pricey as the cost of aviation fuel climbs, even if the underlying production conditions don't change. Higher grain prices tend to push the cost of rearing livestock up. And higher oil prices incentivise farmers to switch to biofuel crops, often at the behest of nervous governments worried about the security of their energy supplies.

Sharply escalating bills at the supermarket checkout fall into the category economists call "high visibility inflation". The increases themselves may not be so large in relation to the earnings of those affected, but they make people feel poorer and make them sceptical about official claims about subdued inflation. Thus they tend to increase inflationary expectations, and pay demands.

Normally the West's central banks would nudge interest rates higher to deal with such pressures, but the fragile state of the world's leading economies makes such action tricky. Some – such as the US Fed – have implicitly favoured a little more inflation over recession. Hence higher inflation co-exists with slowing or stagnant economies. Rising food prices are putting the "agflation" into "stagflation". How has it come about?

Mercifully, some of it is down to temporary factors: freakishly bad weather in east Asia, like the floods endured in the North of England and West Country last year, will have a relatively temporary effect, though the spikes in some prices look severe.

China has been badly affected by cold and rain, pushing inflation to an 11-year high of 7.1 per cent. Tomato prices are up by 138 per cent and pork is 67 per cent more expensive. Reports yesterday that China's food producing regions to the north were suffering from drought drove world soya prices up again. India said yesterday that it may import two million tonnes of grain after dry weather cut the harvest. Floods in Mozambique, Zambia and Malawi have had a devastating impact.

All these situations should improve. The world should also be able to count on an end to the tensions in Kenya that have crippled her output of tea and cash crops. In the case of Zimbabwe, an historically important source of food has long been stymied by President Robert Mugabe's eccentric polices. These, too, may pass.

The immediate outlook – for the next year or so – is likely to stay gloomy, though, because of the low level of world food stocks. The UN's Food and Agriculture Organisation said that these are at record lows, and any attempt to rebuild them will tend to keep food prices elevated. World wheat stocks stand at about 157 million tonnes, against more than 200 million tonnes in 2003. US wheat stocks are projected to fall to their lowest levels in 60 years by May. Speculators have noticed these movements and have, unhelpfully, moved in on "soft commodities" as other high yielding investment opportunities have dried up.

But even if crops and reserves recover, there are more worrying, long- term influences at work that herald an era of permanently dearer food. Most politically controversial is the diversion of crops to biofuel production. The White House has been the most aggressive in its promotion of bio crops, but others, such as the European Union, have also set ambitious targets for the new technology. US production of ethanol from corn has gone from 1.6 billion gallons in 2000 to 5 billion in 2006. President George Bush has set an interim target of 35 billion gallons for 2017 on the way to the administration's ultimate goal of 60 billion by 2030. Brazil and Indonesia are accused by their critics of sacrificing food and biodiversity to bio-ethanol and bio-diesel. Should we grow our biofuel crops in verifiable East Anglia or more efficient South America?

Second, third and fourth-generation biofuels have a much greener impact, but, despite sharply diverging claims, there is little doubt that current biofuel policy is affecting food prices to some extent. Climate change is another unknowable quantity that could transform everything for the worse. But the most significant fact over the next few years will be the economic growth of two of the world's most populous nations – China and India. A combination of growing and more prosperous populations demanding a more varied – often more meaty and less efficiently produced – diet will likely price those in even poorer nations in Asia and Africa out of food altogether. Teeming Bangladesh will perhaps be the most notable loser, an impact exacerbated by rising sea levels. A few nations – Argentina, Bolivia, South Africa – will benefit from higher food prices because of the way their economies are structured.

The obvious move the world's governments could make to alleviate the pain of higher prices seems as distant as ever. The World Trade Organisation's stalled Doha round of trade negotiations could radically improve the workings of the world's food markets, but there is still little sign of them reaching a consummation before November's US elections, at which point a new administration will stall them for many more months.

Genetically modified crops are another politically loaded option to boost agricultural productivity massively; population control another way of meeting the challenge. Demographics, biotechnology and the climate will all profoundly affect the number of people in the world with enough food in their bellies and the cost of our weekly shop. But politics, one way or another, could do an awful lot to alleviate the economic and human costs of agflation.

Agflation hits profits around the world

Kellogg

America's largest cereal maker said last week that "unprecedented com-modity and energy inflation" had forced the Michigan-based trans-national to raise its prices. Its chief executive David Mackay said the rises were "across our global portfolio and across almost all segments."

Nissin Food Products

Japan's noodle champion saw shares slide by a fifth yesterday on fears that higher palm oil prices, currently at fairly low levels, will increase costs in the instant noodle business.

Associated British Foods

Says rising food prices will force it to raise another £150m in working capital. But the Silver Spoon sugar and Twinings tea maker said it had recovered higher costs.

Premier Foods

Shares are down 70 per cent in the last year as it tries to push a 6p inc-rease in the price of a loaf of Hovis past the supermarkets. The price of the average British loaf has risen from 74p a year ago to 82p now.

HJ Heinz

Beans means bucking the trend. The group said its food input costs had risen by 7 per cent this year, but with little impact on profitability: "Our plan is to continue pricing up and aggressively drive productivity initiatives to offset escalating commodity costs in the industry."

Danone

Producer of Actimel and Cow & Gate. The group said it had recorded extra costs of €40m last year and anticipates the same figure in 2008, with the burden already absorbed by previous price rises. It gave a general figure of 5 to 10 per cent for the price rises implemented in recent months.