Sunday, August 22, 2010

Inflation and the International Wheat Market

One site that I monitor that discusses inflation is loudly trumpeting the recent rise in wheat prices as proof of their longstanding belief that we will be seeing lots of inflation, and future hyperinflation. They have forgotten or did not know that inflation is a domestic issue, revolving around a nation’s currency, that price inflation is a rising of the general price level, and that many different things can cause a specific product’s price to change, even without regard to any government activities. They also do not seem to understand the importance of looking at the context of the facts of reality, in this case the international wheat market.

Before looking at the wheat market, I want to emphasize that there is no free market in the world. All markets, including international markets, are affected by individual nation’s attempts to manipulate their own domestic currencies and product markets. Nearly all nations today are manipulating domestic markets directly or indirectly with little restraint. International markets are the total sum of the actions of each nation, plus the actions of individuals and associations of individuals (companies) both to meet normal business objectives and to avoid government restrictions. Whenever international markets are discussed today, these basics must be remembered. If someone talks as if markets were free of interference, we know that they are missing, ignoring, or evading current conditions. It is true that international markets do act independently of any one nation and that the controllers of a nation’s economy are often unhappy with what happens in different world markets. But the markets themselves are fundamentally affected by the actions of different governments, which often overcome real, purely economic or business factors.

Occasionally, and maybe surprisingly within today's context, a market will move as a result of events, real events, not government activity. That is what has happened in the world wheat market. Interestingly, the Russian economy after communism (notice I didn’t call it “capitalistic”) has turned its production of wheat into an export crop. Before, under the communists, Russia had to import wheat, in spite of its very fertile agricultural regions. Russia, as a mixed economy has managed to become a major exporter of wheat. Even so, Russia is not an advanced economy, not even where agriculture is concerned, so that it is more vulnerable to “mother nature”. Russia is suffering from a major draught (see news stories about fires around Moscow, too). Its wheat production has fallen dramatically (the Russian government has now banned wheat exports), and the world price for wheat has risen as supply has fallen, as you would expect.

A rise in a commodity’s price due to a shortage is not inflation. Certainly, if there is inflation, the situation would be worse, which is true today in nearly every country, but they are still two different things. Someone who doesn’t notice the difference does not understand the issues or the economy.

The price of oil is similar to that of wheat, with some additional provisos. The effects upon the international oil market of the actions of individual governments are more obvious, to anyone who looks, that is. The most important result of government action on the oil market is that of reducing the supply of oil, enforced shortage. Governments in many nations have restricted the search for and the recovery of oil. Further, many oil rich nations do not allow private companies to operate in their country, so their search for oil and its production is generally less competent and less successful.

If you have read my earlier posts you will have seen that I have been expecting oil prices to rise to close or above the prices from earlier this decade. The basis of my expectations were that the reasons why the prices was above $100 a barrel would exist again, i.e., increasing demand from the two largest populated countries in the world, India and China. Chinese demand for oil has resumed. India doesn’t seem to be as strong as it was, however. What we have seen is a price that has gone up, but still is significantly lower than it was earlier this decade. I think that the lower price is due to lower demand in the U.S., and probably Europe as well, due to the fact that neither area has recovered from the 2008 recession. Neither area is poised to actually recover, so for the immediate future, we can expect world oil prices to remain lower than the earlier highs. This may be true even though U.S. production of oil is bound to be further constrained by the backlash from the Gulf of Mexico oil spill.

To further my point in this post, oil price increases are not necessarily the result of inflation, either. International oil prices are going to be generally impacted more by direct manipulation by each countries domestic controls. There are so many examples besides the obvious restrictions on drilling and refining, which predominate in the U.S. Most of Europe has taxes on gasoline that make it very expensive, thus cutting demand. Some countries subsidize gasoline sales to consumers, increasing demand. Many of the oil rich countries have nationalized oil ownership and production. It would be interesting to research Indian and Chinese government policies regarding the discovery of oil reserves, production of petroleum products, and the importation and distribution of oil and gasoline. Regardless of those policies, both countries currently require significant importation of oil to support their growing economies, and their increasing requirements will tend to push international prices up. Which is not inflation. An investor, in a fairly rational context, would look upon the emergence of large economies that were actually developing as opportunities for enormous profit.

To that let me add a note regarding commodities in general. I want to talk about the basic stuff of production, i.e., metals, not foodstuffs. Consider a world in which all economies, all countries, were becoming capitalists. The initial supply of the basic materials of production would be stressed to meet the demand of newly productive economies. New mines and processing facilities would be competing for investment funds. Initially, prices for these materials would increase and products worldwide would become more expensive. This would continue for a while because the new mines would be producing material that was harder to extract and more expensive to mine or process. Over time, new mining and processing technology would be discovered which would tend to reduce the cost. Some of the upward pressure on commodity prices is happening now with the emergence of more productive economies. There are opportunities both in the short-run and longer term for investment, profit, and creativity.

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