Linkages In The World Economy

Left: Rice price vs Euro/US$ rate, April 15, 2007 to April 15, 2008


Amazing about how well the correlation is between the value of the Euro, in dollars, and the price of rice. That's because the same phenomenon is driving both:

The global food crisis is a monetary phenomenon, an unintended consequence of America's attempt to inflate its way out of a market failure. There are long-term reasons for food prices to rise, but the unprecedented spike in grain prices during the past year stems from the weakness of the American dollar. Washington's economic misery now threatens to become a geopolitical catastrophe.

Months ago, I offered that China, Russia and other cash-rich nations held the antidote to the incipient credit crisis: "If the US wants to remain the magnet for world capital flows it became during the 1990s, it will have to allow the savers of the world to become partners in the US economy, that is, to buy into its first-rank companies."

No such thing occurred, of course, as Washington has made it clear that it would not allow sovereign funds to own the likes of Citicorp. What are the world's investors doing with the trillion dollars a year they used to invest in American securities, including subprime derivatives and various forms of collateralized obligations that turned out to have more obligation than collateral? They aren't buying American companies because they are not permitted to. They are buying food and other stores of value instead.

...China is exchanging its depreciating reserves of US dollars for things of value, notably rice, with frightening consequences for dependent countries, and deadly consequences for American foreign policy.

The chart ... shows the price of 100 pounds of rice against the euro's parity against the US dollar during the past 12 months. The regression fit is 90%. There is an even tighter relationship between the price of rice and the price of oil, another store of value against dollar depreciation.

As the chart makes clear, the ascent of the cost of rice to $24 from $10 per hundredweight over the past year tracks the declining value of the American dollar. The link between the declining parity of the US unit and the rising price of commodities, including oil as well as rice and other wares, is indisputable. China has bid aggressively for rice all year, and last week banned rice exports, along with Vietnam and several other producers.

For developing countries whose currencies track the American dollar and whose purchasing power declines along with the American unit, this is a catastrophe, as World Bank president Robert Zoellick warned the Group of Seven industrial nations in Washington last week. Food security suddenly has become the top item on the strategic agenda.

Never before in history has hunger become a global threat in a period of plentiful harvests. Global rice production will hit a record of 423 million tons in the 2007-2008 crop year, enough to satisfy global demand. The trouble is that only 7% of the world's rice supply is exported, because local demand is met by local production. Any significant increase in rice stockpiles cuts deeply into available supply for export, leading to a spike in prices. Because such a small proportion of the global rice supply trades, the monetary shock from the weak dollar was sufficient to more than double its price.

It is not only rice, of course, that the cash-rich countries of the world are buying as a store of value; the price of wheat, soy and other grains has risen almost as fast. This might deal the death-blow to America's hapless efforts to stabilize the Middle East, where a higher proportion of impoverished people eat off state subsidies than in any other part of the world. Egypt has been the anchor for American diplomacy in the Arab world since the Jimmy Carter administration (1977 to 1981), and is most susceptible to hunger. Food prices have risen by 145% in Lebanon and by 20% in Syria this year. Iraqis depend on food subsidies financed by American aid.

Reduced to essentials, America's foreign policy sought two unattainable objectives: to stabilize the Middle East and destabilize China. That is an exaggeration, of course, for Washington hoped not to sow instability, but only to put China in its place over the Tibetan affair.

The George W Bush administration might as well have used the State Department as a set for the Jackass reality show. American arrogance has eroded the ground under many of the governments on which its foreign policy depends. It is hard to characterize what will come next, except, like the stunts on Jackass, that it is going to hurt.