Rising food prices: A harbinger of inflation

Cartoon of a rat marked “inflation” eating the contents of a fridge
A sudden increase in food prices would disproportionately affect underprivileged citizens, especially in poorer areas of the world (source: GIS)

Until a year ago, major central banks were aiming to keep consumer price inflation at two percent. This magic figure would supposedly bring about economic growth, prosperity and full employment – even though it reduced the purchasing power of most people and severely punished prudent savers. The accompanying loose monetary policy helped governments maintain their irresponsibly high spending levels. The two percent inflation target served as an expedient pretext for cronyism, allowing central banks to support government spending. 

Inflation reduces purchasing power, and is normally the result of consumer demand exceeding the supply of goods and services. Policymakers assumed that, by pumping money into the economy, they could increase consumer demand. When this failed to materialize, they lamented that consumers do not spend enough. Such ill-considered measures are doomed to backfire. This kind of demand is only sustainable as long as cheap money can be pumped into the economy.  

Harming consumers

Loose money does not necessarily reach consumers. Instead, it has now created bubbles by excessively inflating asset prices (real estate, stocks, company participations, art and so forth). It has also resulted in higher state expenditures and a larger government share in the economy.

In certain countries, people behaved contrary to policymakers’ expectations. Many had justified concerns over the sustainability of overspending and cheap money, and began saving even more. They felt a loss of purchasing power.

The danger of real inflation is looming now, especially in the area where it hurts consumers the most
In the last 50 years, trade, improved logistics, entrepreneurial activities, and new technologies increasing quality and productivity, have drastically reduced extreme poverty and hunger around the world. Life expectancy has increased and child mortality decreased. This success was not driven by easy money, but by real achievements in the economy of goods and services.

However, even before the Covid-19 pandemic, growth rates had been declining. Public debt started to weigh down economies. In the industrialized West, societies began fearing decline. The ever-increasing administration and controlling sector (tax consulting, an oversized regulatory sector, auditing), left unaddressed, contributed to the slowdown by siphoning resources away from manufacturing and real services.

Consumer inflation has not risen sharply so far because of a positive deflationary effect. Deflation hurts when prices fall due to overcapacity. However, with the help of new technologies, prices for certain goods have decreased thanks to higher productivity. With some other products, quality increased while prices stayed the same. While this did not apply to all consumer goods, there was still a significant positive effect mainly brought about by market competition.

The danger of real inflation is looming now, especially in the area where it hurts consumers the most: food prices. This could be harmful to the not so well-to-do in all societies, but especially in the poorer regions of the world.

Political stability at risk

The Food and Agriculture Organization (FAO) publishes a monthly Food Price Index. The figures for May 2021 are alarming. Food prices always vary, as they depend on harvests and the weather. But the index shows an increase of some 4.8 percent since April 2021 and 39.7 percent compared to May of last year. This rise was caused by several factors, including production costs, currency issues, weather changes, variations in demand, and the use of maize for biofuel. The prices of cereals, vegetable oil, dairy, meat and sugar saw the largest increases. It is possible that the price of food commodities will go down again. But this would be unlikely in the near future, due to more demand. Protectionist policies, trade disputes and sanctions could exacerbate the situation.

A short-term rise in food prices could trigger an outbreak of inflation that would go far beyond the two percent mark. Lower prices of oil and gas would not offset these higher prices, and the transition to renewables will likely increase the cost of electricity. 

Once inflation starts, it is very difficult to rein in. Food prices are key indicators, and they can affect political stability when they spiral out of control. The Arab Spring started in Tunisia and Egypt because of higher food prices. 

If interest rates were to increase, the financial position of the already bankrupt governments would become untenable
Today’s loose monetary policy will not keep inflation at two percent. Traditionally, purchasing power is preserved and prices stabilized by adjusting interest rates and taking liquidity out of the financial system. However, under the pretext of fighting the consequences of Covid-19 and stimulating a “green economy,” even more money is being pumped into the system. If interest rates were to increase, the financial position of the already bankrupt governments would become untenable.

Inflation could be welcomed by some cynics in policymaking, as governments might be hoping it will lower the cost of their debt. But in practice, this would be a hidden tax that would mostly affect the poor. From a mathematical standpoint, inflation reduces debt. But if this “debt relief” comes, it can easily get out of control and government expenses will likely rise as well. As a result, societies would be burdened with both debt and inflation.

In recent years, the official inflation statistics in the Western world showed stable prices. However, consumers were already being affected by the erosion of their purchasing power. The basket of goods services used as the basis of the index was not necessarily representative.

Impending crisis

Several businesses had to close because of the economic damage inflicted by the recent lockdowns. Additionally, Covid relief funds paid to the unemployed could discourage people from returning to work, thus affecting the labor market and causing more government spending. The resulting vicious cycle would jeopardize price stability, especially in the United States.

The irresponsible spending policy of most states, in combination with overregulation, market interventions and oversized governments, was never sustainable and will inevitably lead to a major depression. Covid-19 has accelerated this process.

The success of Western economies, especially European ones, was driven by small and medium-sized family businesses. They lent resilience to increasingly fragile societies and economies. While many governmental institutions are still overblown relics of the 19th century, the business environment has evolved. The innovative spirit fostered by free markets led to prosperity. But now inflation will hurt this stronghold.

The tax cartel promoted by the G7 is a tool to help governments
The way out of this quandary would be to promote a strong free economy. Sadly, the opposite is taking place. The tax harmonization now planned will offer short-term relief to the governments of large states, to the detriment of regional development. The tax cartel promoted by the G7 is a cynical, short-lived tool to help governments. The detrimental consequences will not only be passed on to the next generation – they will appear very soon. The measure has been praised as an act of “justice,” but an outcry would be more appropriate.

Instead of betting on family businesses and entrepreneurial firms, governments are expanding. One can only hope they will change course before it is too late. However, it seems a major disruption will be necessary for such a realignment to take place.

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