Block’s Indicator of Sustainable Growth

The relationship between food prices skyrocketing around the globe, and subsidies on ethanol and biodiesels has been exposed by a confidential World Bank report. The report was prepared in April 2008, but never released for fear of offending its principal sponsoring country, the US.

Says the World Bank: “Biofuels have forced food prices up by 75 per cent, far more than previously estimated. Rising food prices have pushed 100 million people worldwide below the poverty line, sparking food riots from Bangladesh to Egypt.”

The power of farm lobbies to enhance and entrench advantages for themselves knows no end in both United States and Europe. Politicians are like putty in their hands. The 75 per cent increase contradicts US government estimates that plant derived fuels have contributed less than 3 per cent to food price increases.

The Bush Administration links higher food prices to higher demand from India and China. But this is denied by the World Bank report. Says the World Bank: “rapid income growth in developing countries have not led to large increases in global grain consumption and was not a major factor responsible for large price increases.”

The G-8 country leaders meeting in Japan (July 8-9 2008) expressed suitable concern about escalating food and oil prices, but took no immediate action. The Japanese hosts gave the leaders a six course lunch and a 18 course dinner banquet, a hypocritical gesture demonstrating that pious talk without action about the growing food shortages shows how much real interest they have in the world’s poor.

Back in 2005, the G-8 leaders promised to increase global aid by 25 billion Euros a year by 2010. But the rich nations are only 14 per cent of the way towards hitting the target.

Other causes of higher food prices include the prolonged impact of the drought in Australia reducing that country’s wheat exports leading to a marginal reduction in the supply of world wheat stocks, and blue ear disease in China disrupted pig supply last year contributing to a 15.4 per cent increase in Chinese pork prices over the year.

The price of soybeans has doubled over the year, lower rice supply impeded by water shortages in South East Asia has led to a doubling in prices since the end of last year, with the world’s largest rice importer, Philippines ordering 1 million tons to feed its population. Water shortages has also affected rice production in Central America and West Africa.

The same trend to rapid rises in food prices, without the extreme effects in poorer countries is evident in America and other developed countries. In the US, the price of milk is up 17 per cent over the last 12 months, with a similar increase in dried beans, peas and lentils. The price of cheese is up 15 per cent, rice and pasta up 13 per cent, bread up 12 per cent. An even sharper rise in price of eggs over the last year is up 25 per cent, and up 62 per cent over the last two years.

Simon Johnson, chief economist of the International Monetary Fund also believes that ethanol and other biofuel subsidies are a major factor driving higher food prices. The IMF’s staff assessment is that a “significant part of the latest jump in food prices can be traced directly to biofuels policy.” Unless the policies are reversed, the impact of subsidies leading to a jump in ethanol supply, against the backdrop of protracted high food prices in coming years is going to be sharply more evident.

Still another factor involved in high food prices is the extent of speculation in the $US 5 trillion futures market for food commodities and oil. Senator Joe Lieberman, who chairs the US Senate committee on home security and government affairs said on July 7 2008: “My own conclusion is that index speculators are responsible for a big part of the commodity price increases.”

When you allow for world population expected by the United Nations to rise from a current 6.7 billion in 2008 to 8.9 billion by 2050, and the impact of global warming affecting agricultural production, with extremes in land degradation and weather conditions, can the world sit idly by and allow a speed up in diversion of food supply to expansion of biofuels?

This will show up in a rapid rise in diversion of corn from the foodstuff supply chain to ethanol feedstock, with a much greater increase in agricultural land dedicated to biofuel raw materials reducing the availability of foodstuffs. As ethanol and biodiesel production escalates, large increases in water usage dedicated to the biofuel market has started to impact on water availability in some US cities and towns.

The Institute for Agriculture and Trade Policy in Minnesota, the only US state which has publicly available records on ethanol’s water consumption says in a 2006 report that average water use in ethanol plants has been reduced from 5.8 gallons water per gallon of ethanol in 1998 to 4.2 gallons in 2005. This indicates greater efficiency over time, but ethanol is still costly in water usage.

Water availability will challenge the ethanol industry in many regions, particularly west of the Missouri River. Science Daily (October 11 2007) reported a National Research Council study saying that the rapid increase in ethanol production from corn could significantly harm water quality.

Rising increases in world oil prices, in conjunction with ethanol subsidy policies, has led to an explosion in corn ethanol production, and further expansion over the next 10 years will be even more dramatic. The new energy act passed by Congress basically mandates an increase in ethanol and biodiesel output to reach an annual goal of 36 billion gallons by 2022. Current US production in early 2008 is about 7 billion gallons, nearly all from corn and soybeans.

Biodiesel subsidies in the European Union has also had a similar experience to that of United States, particularly in a large diversion of farm land from dairy production into crops used for biodiesel production. This is particularly evident in rapeseed, with resultant sharp increases in price.

While politicians like the biofuel expansion because it reduces dependence on Middle East oil, reality must also be taken into account. As a Wall Street Journal editorial (October 17 2007) pointed out: “to replace just 10 per cent of gasoline and diesel consumption, the US would need to convert a full 43 per cent of its cropland to ethanol production.”

While the US and Europe are high cost producers of biofuels, there is at least a partial solution at hand. Brazil is ideally placed as the ethanol producing centre for the world. It is the low cost producer, due to the size of its sugarcane-ethanol industry and corresponding availability of bagasse (the solid residue after juices are pressed from the sugarcane stalk) as feedstock in the mills.

This was one of the conclusions from the Oak Ridge National Laboratory (ORNL) study Biofuel Feedstock Assessment for Selected Countries (2007). The only obstacle is that both the US and Europe have high tariff walls against imported Brazilian ethanol.

high food prices, low cost producer, exports, ethanol, biodiesels

Back in the 1970s, stagnant economies and rising inflation on the back of three OPEC oil shocks was a major handicap to growth. 2008 has similarities with the 1970s, with recessions in both the US and UK, and the European Union and Japan not doing that much better.

In all these countries, inflation is on the rise with rising prices in both oil and foodstuffs. This is stagflation and it shows no signs of moderating.

By comparison with the stagnant growth in the industrial countries, the developing economies in Asia are still growing strongly, but governments are losing the battle to keep prices at stable levels.

Stephen Roach, the chairman of Morgan Stanley said in the Financial Times (June 12 2008), that the surging inflation rate in Asia, the world’s industrial producer has dangerous risks to the global economy.

In developing Asia, consumer prices rose by 7.5 per cent in the four months to April 2008, close to a nine and a half year high, and more than double the 3.6 per cent pace of a year ago. Food makes up a giant share in the make up of the CPI index. In China, the CPI weighting for food is 33 per cent and in India, it is even higher at 57 per cent.

The only good news in recent weeks was the UN Food and Agricultural Organization reporting in July that food commodity prices has slowed down since March 2008.

Even when you strip out food and energy prices, the inflation rate in developing Asia was still at double the rate of last year reaching 3.8 per cent in April.

Given its industrial size, the main country culprit is China with the average annual inflation rate surging 8.3 per cent in the four months ending May 2008.

The irony is that in the last decade, it was cheap Chinese exports along with tight wage growth in the west, which kept inflation under control in both America and Europe. A reversal was becoming evident in 2007, with rising Chinese export prices and 2008 is repeating the price patterns of last year. Asia is now exporting inflation to the west.

China’s inflation battle has finally been slowed, with government controls further restricting lending and raising bank reserve requirements to record levels. After April’s CPI increase of 8.5 per cent, China’s inflation rate had moderated to 7.1 per cent in June.

While Chinese food prices have finally settled down at least for now, the inflation ogre is still around, with higher prices in non-food categories. Record capital inflow into China has contributed to excess domestic liquidity, compounding the task of curbing inflation.

One area that is more difficult to control is energy prices, which as in most other Asian countries is somewhat protected by fuel subsidies, but these are slowly being reduced. China, with record electricity generation growth is forced to import ever larger quantities of coal, where prices have sharply increased over recent months.

Chinese producer prices have accelerated faster than the CPI in the last two months, reaching 8.8 per cent in June, squeezing producer margins. At the same time, higher energy prices lifting costs for the industrial sector, with wage increases and the sharply rising import bill for commodities point to additional price pressures in the months ahead.

India hasn’t been as successful as China in inflation control, with price pressures still very strong. The inflation rate in the 12 months to July 5 was a high 11.9 per cent. Inflation is now at a 13 year high well above the political comfort level of 5.5 per cent. Along with prices, interest rates have also increased reaching 8.25 per cent, its highest level in six years.

Indian salaries are expected to rise by 15 per cent a year until 2011, not a good sign of bringing inflation under control. Across the border, Pakistan’s annual inflation rate is even higher rising to an annual rate of 19.3 per cent in May.

Singapore, for long a model of consistency in high productivity growth and low inflation is now having its tough with a 26 year inflation rate high of 7.5 per cent against the background of a shrinking economy.

The International Monetary Fund expects inflation to hit 9.1 per cent in the emerging world this year and remain high at 7 .4 per cent in 2009.

The spectre of rising inflation has seen Eurozone inflation reaching a high of 4 per cent in June, double the European Central Bank target, while the US CPI rose to a 17 year high cent of 5 per cent in June. Pimco, the world’s largest bond fund is forecasting inflation to remain above central banks’ targets for several years.

Monetary Fund, emerging world, Eurozone, US CPI, global economy

Goldman Sachs’s oil analyst Arjun Murti was right on the money about crude oil prices. Back in March 2005, when the oil price was US$ 55 a barrel, Murti correctly forecast that the black gold could spike up to $105. The oil price has currently increased further to around $145.

Last month, Murti put his forecasting hat back on again and suggested the possibility of $150-200 a barrel, increasingly likely over the next six to 24 months. The current president of oil producers OPEC is also suggesting the likelihood of $200.

The silliest thing would be to dismiss Murti’s forecast out of hand. He is one oil analyst with a good record of anticipating future prices, and he wouldn’t be working for Goldman Sachs, which trades oil if he wasn’t good at his job.

I’m not surprised by the jump in oil prices to record levels. I am a strong believer in peak oil, which says that the world oil supply is fast reaching peak level, and taking the annual depletion factor into account, supply will soon start to fall. Oil demand continues to grow strongly and will start to outrun the available supply.

Remember the days of oil at $16.70 a barrel. That was last on November 19 2001. It then rose up to an average of $72.36 in 2007. Record prices have failed to stem rising consumption in China, India and other developing countries.

Estimated Oil Production to 2030
Annual Rate –Regular Oil

Heavy etc includes tar sands and oil shales
Source: Association for the Study of Peak Oil and Gas (ASPO) at May 2008

If the ASPO estimates prove correct, there will be a large oil shortfall between demand and supply by 2030. These estimates have been attacked by the oil industry. OPEC, the Middle East oil cartel in its latest forecast (July 10 2008) predicts world oil demand rising to 113 million barrels/per day by 2030, with non-OPEC oil supply reaching 60 million barrels/day. Of the total, 11 million b/d would come from unconventional oil, mainly tar sands from the large Canadian deposits, which would be very costly to produce.

Says OPEC: “With a large and increasing resource base, together with the vast amounts of unconventional oil, availability is not an issue. There is enough oil to meet the world’s needs for the foreseeable future. What is an issue, however, is the deliverability of the required oil. It is here that the industry faces several key challenges, as well as associated opportunities.”

Whichever scenario works out- whether a shortfall in oil supply or more adequate oil supply by 2030, the price of oil will keep on increasing, making it a burden on the world economies. $200 a barrel is a near term goal, and the price will keep on rising.

The CSIRO, Australia’s scientific and industrial research organisation estimates in its July 11 2008 report that in the most extreme case, an oil price of $A8 a litre by 2018 is possible if oil production peaks. As there are almost 159 litres in a barrel of oil, the astonishing price would work out at $1,272 a barrel.

Americans complain of gasoline at nearly $4 a gallon, not realising that in most western countries it sells for much more than that. So, what would you do if oil prices rise even more strongly to say $6 or $8 a gallon

US sales of gas guzzling SUVs along with pick up trucks have been falling off dramatically. One Denver showroom was desperate enough to offer a year’s free petrol with each new SUV, and he wasn’t rushed. Michael Jackson of car retailer Autonation is quite emphatic when he says that “the era of the truck-based large SUV is over.”

Lumbering big American vehicles are being bypassed by the more compact fuel efficient four cylinders, whether from American assembled Toyotas and Hondas, or from Asian imports. In some cities, sales of hybrids have been soaring to the extent that Ford has now joined a market opened up by Toyota and Honda. General Motors has set up a dedicated department to produce hybrids and electric cars, and both Mercedes and Audi will also join the race in hybrids.

Hybrid cars, which complement gas engines with electric motors to improve gas mileage is one answer to impossibly high gasoline prices. What about an all electric car as a solution to cheaper transportation costs? The Americans took an early lead with the first electric taxis to be introduced in New York City in 1897. Believing that electric cars was the next big thing, the great inventor Thomas Alva Edison in 1899 began a research project to create improvements in the alkaline battery, but he abandoned his experiments a decade later.

In 1900, 4,182 cars were produced in United States, of which 28 per cent were electric, and in that year electric cars represented about one third of all cars on New York roads. But this promising start soon came to an end, with Henry Ford’s introduction of the model T mass produced gasoline driven car, and the 1912 invention by Kettering of the first practical electric auto starter.

A brief honeymoon with the electric car came in 1966, when the US Congress introduced a bill recommending the production of electric cars, and a poll found that 33 million Americans would be interested in buying such a car. The biggest advocate of a hybrid electric car, Victor Wouk built a full powered hybrid with a Buick supplied by GM, but this program was killed off in 1976. In 1999, Honda produced 300 electric cars in California at the request of the state government, but then abandoned the project.

What about the promising research in hydrogen fuel cells? When can motorists expect some good news? Canada has been an early leader in fuel cell and hydrogen research, and Vancouver has the world’s largest fuel cell cluster. The American Government has also committed substantial resources to fuel cell research.

But early commercialization is still years off. David Ghosh, director of science and technology at the National Research Council’s Institute for Fuel Cell Innovation in Vancouver (May 1 2007) said that in terms of visibility, automotive uses capture people’s imagination. It’s a huge market, but the cost has to be low, and the durability high. Ghosh says: “The automotive application is probably going to be the last one to be commercialized.”

It is thought that commercial applications will start in a niche market, like backup power for telephone towers and data centres. Ghosh says “we’re in the demonstration stage. The issue has been cost. Hydrogen power currently costs two to five times higher than today’s energy costs. Conventional energy costs around $600 to $800 per kilowatt. Energy from a hydrogen fuel cell costs about $2,000 per kilowatt.

The need is to get the cost down by about two to four times. Can we expect a hydrogen fuel cell powered car by 2020? Possibly, but at the snail pace of current development, it may not happen. So, the only good news is to rely for now on a hybrid car, and hope that if all the car companies join the hybrid movement, an all-electric car will eventuate.

The shock of high oil prices is in turn driving up the price of foodstuffs when you allow for the rising prices of diesel on farm costs, which is a double blow for the consumer.

You could put your gas guzzling SUV into retirement and invest in a fuel efficient car along the lines of Toyota, or Honda for a start. If you want a car to run around your neighbourhood for ferrying the kids to schools, or shopping at the supermarkets, there are a few models of electric cars available. Such as Zac which imports electric cars from a supplier in China. The Zac people claim

Hybrid car technology complement gas engines with electric motors to improve gas mileage, or to increase power through the use of a combined propulsion system. Most car makers are now working on a hybrid, and the number on the market will grow sharply, as the demand and competition grows substantially. The website CNET.com features the top hybrids on the market.

Wayne Cunningham, senior editor in a report dated June 2007 ranks the cars on great gas mileage and good performance. The three “spectacular” models were three Toyotas comprising the 2008 Lexus LS, the 2007 Toyota Camry Hybrid and the Lexus GS four wheel drive sedan. In the “very good” category, were the 2007 Honda Civic hybrid, the 2008 Mercury Mariner Hybrid, the 1006 Honda Accord hybrid, the 2006 Lexus RX, and the 2005 Toyota Prius.

oil barrel, $200, oil producers, OPEC

Welcome to my blog. I’m Ray Block, macro economist, concerned citizen on global warming, and its impact on rising world inflation.

With millions of blogs on the internet, why another? The purpose of this blog is to become an aggregator site, bringing together up to date information on commodity price inflation, the drawing down of world resources faster than replenishment, and global warming effects on commodity supply.

A little over 200 years ago, another economist, the Rev Thomas Malthus was convinced that population growth would eventually outrun commodity supply. There is some element of truth in this belief, and even the Club of Rome, a non political think tank believed in the 1960s, that there was a limit to food supplies, which the rapid world population growth would eventually lead to food shortages. This was proven wrong at that time, but elements of Malthus is finally coming to pass, with record food price inflation and food riots in many of the poorer countries.

There exists currently the bringing together of a series of reinforcing factors, which in combination is leading to a dangerous period ahead. These are:

* The beginnings of the worst global recession since the 1930s leading to rapid unemployment and yet high inflation.

* Major world banks in credit rationing mode after the destruction of capital due to the credit excesses of recent years leading to a severe credit crunch which commenced in August 2007 and will continue through to end of 2009.

* A continuation of the super commodity cycle which commenced in 1999 and has at least another 20 years to run.

* The need to take quick action on global climate change leading to inevitably large increases in energy prices.

* A global limit to world supplies of hydrocarbons impacting on rapid world demand resulting in continuing price escalation to record levels.

* Unsustainable increases in world population leading to greater misery in the third world.

* The need as never before for sustainable growth as the only way forward.

The Club of Rome authors in their 30 year update in 2002 drew attention to the reckless “drawing on the world’s resources faster than they can be restored, and we are releasing wastes and pollutants faster than the earth can absorb them or render them harmless. They are leading us toward global environmental and economic collapse- but there may still be time to address these problems and soften their impact.”

World population currently 6.7 billion is forecast to rise to 8.9 billion by 2050. 350 years ago, the world population was doubling every 240 years. The population doubling effect took only 100 years by 1900. By 2050, the world population will have more than doubled in 80 years.