What's driving the surge in food prices and what are the knock-on effects?

Data from the Food and Agriculture Organisation's (FAO) monthly food price index, shows prices in May were 40% higher compared to last year. John Stepek looks at what is causing higher food inflation.

We've been talking a lot about inflation in the past few months. For most, the jury is still out as to just how troublesome and persistent inflation will be.

However, one set of prices is already rising at double-digit rates. And it's in a category with probably more potential than any other to cause political and social upheaval.

We're talking about food prices...

What's behind the surge in food prices?

Food prices are rising at their fastest rate since 2011. According to the UN Food and Agriculture Organisation's (FAO) monthly food price index, prices in May were up an extraordinary 40% on the year before.

The food price index is a composite of five other indices measuring different food groups: cereals, vegetable oils, dairy, meat and sugar. They're all a lot higher than they were a year ago, vegetable oils in particular (biodiesel is a big culprit here).

As Chelsea Bruce-Lockhart and Emiko Terazono report in the FT, the cost of everything you need to make a cooked breakfast has gone up sharply – coffee, milk, sugar, wheat, oats and orange juice are up by nearly 30% on 2019 levels. The price of pork is up more than 50%.

A number of factors are driving the surge. Weather is obviously a huge issue in food production and a drought in Brazil has been partly to blame for some higher prices, though this has been offset somewhat by better conditions in the US and EU.

But in terms of the overall problem, it's mostly down to coronavirus-related disruption.

The pressure on supply chains has affected production and distribution of food. It's become more expensive to grow and more expensive to ship around the world. Governments have also been stockpiling grains during the pandemic, notes the FT. And then there's the re-opening factor: as the restaurant trade opens up again, that will result in more demand.

In all, says Abdolreza Abbassian of the FAO, the system is looking fragile: "We have very little room for any production shock. We have very little room for any unexpected surge in demand in any country."

The good news – in the longer run – is that the cure for high prices is high prices. When farmers see that prices are high they will want to plant as much as they can, and in turn that will bring prices down in time. It's also much quicker to shift agricultural resources than it is to find a new seam of copper or tin, for example.

So from a specific investment point of view, the most practical way to invest for rising food prices is to invest in the equipment that farmers will be buying as they gear up to grow more of the stuff.

However, it's fair to say that agricultural equipment stocks have come a very long way in the last year. John Deere's share price has more than doubled in the past year, and has tripled from its low in March 2020. It's trading on a price/earnings ratio of 24, which looks steep.

At a glance, potash and fertiliser companies look more promising – Mosaic is one option to investigate further if you're interested. (There are ways to trade the prices of agricultural commodities directly but it's a high-risk area and not worth bothering with unless you already know what you're doing).

How food prices impact on the bigger picture

However, that's the longer run. In the shorter run, a bigger concern for us all - including investors - might be the potential impact of food price inflation on the bigger picture environment.

The consumer price indices that developed world central banks pay the most attention to ignore things like food and energy prices. It's easy to mock this, but there is a reasonable rationale behind it. Such prices are prone to spikes and slumps, and so they make the data noisy.

However, it's one thing when we're seeing minor cyclical variations. It's another when we're seeing the sorts of persistent price surges that can have real world consequences.

Surges in the prices of food and fuel might be the sort of thing that central banks "look through". But they are profoundly disruptive in a way that other forms of inflation simply aren't.

Higher food prices aren't as politically incendiary in developed nations as higher fuel prices are, simply because they account for a much smaller proportion of most people's spending.

But they are a very serious issue in developing nations, and you don't have to look very far back to see examples. Rising food prices were definitely a contributing factor to global unrest in both 2008 and in the "Arab Spring" protests of 2010 and 2011.

China is particularly sensitive – soaring food price inflation is widely viewed as a major driving force of the protests in 1989 that led to the Tiananmen Square massacre. In a recent piece for Gavekal, Louis-Vincent Gave notes that this is likely one reason why China has been allowing the renminbi to rise so sharply in recent months - to help keep a lid on inflation.

For now, it's just something to keep an eye on. But it's another factor that may well push emerging economies to end up raising interest rates more quickly, and pushing them higher, than they otherwise would have. We'll have more on the potential consequences of this in a future issue of MoneyWeek magazine (get your first six issues free here if you aren't yet a subscriber).

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