Archive for June 18th, 2007

Food Prices could rise higher in future

June 18, 2007

These days, agriculture seems to be attract my attention quite a bit. I read this speech from Alan Bollard, Governor of Reserve Bank of New Zealand where he talks about agriculture and rising commodity prices.

The reason for rising prices is partly China. He adds:

The rapid pace of industrialisation of China, coupled with its relatively low per capita endowment of natural resources, has led to a sharp increase in world commodity demand. For example, according to the International Monetary Fund, China was responsible for 51 per cent of the growth in the world copper market from 2002-2005, 54 per cent of the increase in the steel market, 48 per cent of aluminum growth and 87 per cent for nickel.

However, what caught my eye is this:

The most marked increases have been in dairy prices. Over the last year, dairy prices have increased by 73 percent. Milk powder prices have led the way, rising almost twice as fast as other dairy products.

Why prices have increased?

In large part, the recent gains in dairy prices can be traced back to a basic imbalance between global demand and supply. Global demand for protein has been on a structural uptrend for some time. Demand for protein is very income sensitive and rising income levels in emerging markets have led to improvements in diet, incorporating more meat, eggs and milk. In recent years, the strongest growth in consumption of dairy products has come from emerging Asian markets, particularly China.

Why Supply hasn’t caught up:

1) At the same time, dairy production from the major exporting regions, such as New Zealand, Australia and the European Union (EU), has been relatively lacklustre, hampering the ability of global dairy supply to meet the growth in demand.

2) The recent boom in biofuel demand has further hindered global dairy supply. Strong demand for ethanol has seen corn prices, the primary source of livestock feed, advance over 50 percent in the past six months.

The outlook for future is prices could rise further:

There is certainly no compelling reason to suggest that strong global demand for dairy products will slow markedly soon. Supply responses in dairy are slow inevitably slow. And with the boom in biofuel demand sending production costs in many parts of the world soaring, the ability of supply to “catch-up” to demand will be constrained further. As a result, any increase in global dairy supply may well rest on the prospects for emerging exporters such as Argentina and the Ukraine, along with the ability of China to increase production to meet its own demand. It is certainly possible that we could be heading into a “new era” for dairy prices.

He then goes on to talk about impact on NZ economy (a good snapshot). But the graphs etc presented are very good. Thanks Mr. Bollard.

Update 1:

I just checked the above mentioned food prices in India. (The website of Office of Economic Advisor (under Ministry of Commerce and Industry) provides detailed analysis of the Wholesale Price Index , the most popular measure of inflation in India). Here are a few findings:

1. From March 2006 onwards foodgrain prices (cereals and pulses) have been increasing in double digit every month vis a vis same month pervious year ( i.e. comparison is between March 2006 and March 2007 and so on).

2. Poultry Products ( Eggs, Meat & Fish) saw double digit growth rates from July 2005 onwards to June 2006. And now again from Feb 2007 there is an increase in the index .

3. There has been a huge jump in prices of milk powder when we see double dogit increase from March 2006 onwards but the index has not increased, hence it is basically more of base effect. The prices are not incvreasing but when we see the year on year growth the numbers are in double digits.

So, bit of a mixed story. But yes we see quite similar trends in India as shown by Bollard in his speech. Keep watching this space for developments.

Update 2:

Apurv rightly asks:  “Well, dairy products price rise is understandable based on your post. But how is it just possible to generalize it to include all food products? Confused a bit..”

My apologies for missing out that point. The dairy products are consumed by themselves and are also used to manufacture other food products as well. For instance cakes (eggs, cream) , Processed Cheese (milk), Salaamis (meat) etc all need some form of dairy/poultry items.

Thanks Apurv once again.

Bernanke answers my problem finally

June 18, 2007

I have often wondered and asked this question elsewhere as well (here and here) that why finance has not been given its due in discussion on growth and development.

I had read number of papers on the subject which said why finance is important for growth and number of ways it helps but none which said why finance has been ignored after all in growth literature.

Bernanke in his latest speech answers the same in his usual simple yet profound style:

Economists have not always fully appreciated the importance of a healthy financial system for economic growth or the role of financial conditions in short-term economic dynamics.  As a matter of intellectual history, the reason is not difficult to understand. 

During the first few decades after World War II, economic theorists emphasized the development of general equilibrium models of the economy with complete markets; that is, in their analyses, economists generally abstracted from market “frictions” such as imperfect information or transaction costs.  But without such frictions, financial markets have little reason to exist.  For example, with complete markets (and if we ignore taxes), we know that whether a corporation finances itself by debt or equity is irrelevant (the Modigliani-Miller theorem).

Then how did all of it begin?

The blossoming of work on asymmetric information and principal-agent theory, led by Nobel laureates Joseph Stiglitz and George Akerlof and with contributions from many other researchers, gave economists the tools to think about the central role of financial markets in the real economy.  For example, the classic 1976 paper by Michael Jensen and William Meckling showed that, in a world of imperfect information and principal-agent problems, the capital structure of the firm could be used as a tool by shareholders to better align the incentives of managers with the shareholders’ interests.  Thus was born a powerful and fruitful rejoinder to the Modigliani-Miller neutrality result and, more broadly, a perspective on capital structure that has had enduring influence.

Hmm, so the assumption of perfect markets was the main reason why finance was never considered important.  A great thought. Thanks a ton Ben. Your team at Fed is superb at speeches and educating people like us. Read this for how finance helps:

Economic growth and prosperity are created primarily by what economists call “real” factors–the productivity of the workforce, the quantity and quality of the capital stock, the availability of land and natural resources, the state of technical knowledge, and the creativity and skills of entrepreneurs and managers.  But extensive practical experience as well as much formal research highlights the crucial supporting role that financial factors play in the economy.  An entrepreneur with a great new idea for building a better mousetrap typically must tap financial capital, perhaps from a bank or a venture capitalist, to transform that idea into a profitable commercial enterprise. To expand and modernize their plants and increase their staffs, most firms must turn to financial markets or to financial institutions to secure this essential input.  Families rely on the financial markets to obtain mortgages or to help finance their children’s educations.  In short, healthy financial conditions help a modern economy realize its full potential.  For this reason, one of the critical priorities of developing economies is establishing a modern, well-functioning financial system.  

The speech is a super-one and helps one understand/revise his concepts of finance. He further says he looked at two channels in 1983 by which the financial problems of the 1930s may have worsened the Great Depression:  

The first channel worked through the banking system.  By developing expertise in gathering relevant information, as well as by maintaining ongoing relationships with customers, banks and similar intermediaries develop “informational capital.”  The widespread banking panics of the 1930s caused many banks to shut their doors; facing the risk of runs by depositors, even those who remained open were forced to constrain lending to keep their balance sheets as liquid as possible.  Banks were thus prevented from making use of their informational capital in normal lending activities.  The resulting reduction in the availability of bank credit inhibited consumer spending and capital investment, worsening the contraction.

The second channel through which financial crises affected the real economy in the 1930s operated through the creditworthiness of borrowers.  In general, the availability of collateral facilitates credit extension…… However, in the 1930s, declining output and falling prices (which increased real debt burdens) led to widespread financial distress among borrowers, lessening their capacity to pledge collateral or to otherwise retain significant equity interests in their proposed investments.  Borrowers’ cash flows and liquidity were also impaired, which likewise increased the risks to lenders.  Overall, the decline in the financial health of potential borrowers during the Depression decade further impeded the efficient allocation of credit……

He goes on to explain the concept of external finance premium, Financial Accelerator, Monetary Policy and credit channel, all very useful concepts. Must read for a finance professional (those with non-finance background can go through it as well).

Assorted Links

June 18, 2007

1. I am really confused with so many perspectives. There is no clarity on what works for growth and what doesn’t. Dani Rodrik points out here and here.

2. Rajeev Malik in ET on Rupee and Capital Flows

3. I am more confused when Mythilli at ET points out to a paper that says trade is good

4. Vinayak Chatterjee in BS rightly says we need to define What is infrastructure first and then look at building it. He says there are 6 official entities with their own definition of infrastructure- Finance Ministry, Income Tax Deptt, RBI, IRDA, Planning Commission and Prime Minister’s Committee on Infrastructure!!

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