In Epik’s 2011 Outlook, we said to expect inflation this year. Well, that did not take long. The headlines these days are full of news of inflation — specifically inflation in the things you need (food, fuel, clothing) and deflation in the things you don’t (a larger house or a new boat). To date, this inflation hit has mostly been observed in producer prices but not in consumer prices. That could well change soon, particularly once excess inventories are liquidated.
In the meantime:
- The supply of things you need is potentially shrinking: I don’t want to sound excessively Malthusian but for the first time in my life, I am sensing that there is a risk risk of widespread famine. The group most at risk is the nominally 1 billion people living on less than $2 a day. However, if the 2011 harvests are as bad as they look like they might be, the pain will quickly expand to those living on $10 a day and quite possibly higher. For calibration, something like 80% of humanity lives on less than $10 a day.
- The Inflation catapult is locked and loaded: Inflation is largely a monetary phenomenon. For inflation to occur, you either need (1) more money chasing the same amount of product, or (2) equal money chasing less product. In the case of food inflation, we may have the worst possible combination: more money chasing less product. The below chart explains perfectly why I think the inflation catapult is primed for blast-off. It awaits a triggering event.
- The Inflation hawks have left the building: Earlier today, there was news that Neil Barofsky is leaving his role as SIGTARP. These are the guys who are accountable for where the TARP bailout money goes. On a related note, Hawkish Fed Governor Kevin Warsh resigned last week. Axel Weber, the similarly hawkish heir apparent to the European Central Bank, also resigned last week. The hawks appear to be leaving the building.
You may not care about the money supply, and may well not know your M1, M2 and M3. Now would be a good time to get up to speed — before the velocity of money returns to trend. It is also a good time to diversify into assets that have finite supply and that have global appeal. Personally, I like premium domain names as an asset class for reasons discussed prior.
The Chinese need to eat too — and with $2.65 Trillion in ForEx reserves they can afford to!
The big macroeconomic development to watch in the coming months is Chinese food inflation. Month over month, the official number is that it is running a TRIPLE DIGIT annualized growth rate. I have an ongoing Skype dialog with a business partner in Fuzhou, China, who has confirmed that rapidly increasing food prices in late 2010 is now accelerating in 2011. Due to ongoing drought, China’s domestic harvest could take a large hit in 2011. However, keep in mind that China also has the world’s largest foreign exchange reserves, now above $2.65 Trillion. In other words, in a global market with free trade, their government should be able to import what they need from willing exporters. Interesting to note though that Russia has banned grained exports in the wake of their own failed harvest.
I goes to follow then that China is the X-Factor in global pricing of food — they would have the greatest need and also the greatest capacity to pay for it. Although drought conditions are not new in China, 2011 is looking particularly severe. This is the first time that I can recall when the world’s most populous nation can also afford to outbid the world’s wealthiest nations for a good that is classically price inelastic.
Guess who has the largest supply of exportable grain?
As you can see in the below info-graphic, far and away the US is the leading exporters of food.
At a time when food will be much more expensive, let’s see if the US crop holds up. It just might, and almost certainly on a relative basis. The (geopolitical) implications are significant as there is mounting evidence that instability in places like Egypt have their origin in rising food prices. Said another way, a government would spend as much as needed to maintain control of its population. With 43 million Americans on food stamps at a time of record budget deficits, the writing is on the wall that more debasement of the currency can be expected as the global trends towards income equality and wealth concentration continues. Hedge accordingly.