2 April 2008

Agflation will change the course of history

BY MATEIN KHALID (At Home)

2 April 2008



WHILE consumers, savers and financiers in the Gulf fret about the current inflation surge and rightly attribute it to the dollar peg, offplan madness and the property speculation bubble, the prices of cement and steel, rent spirals, wage spikes, the money supply, 30 per cent bank credit growth and the tooth fairy, I am convinced that the Middle East’s next macroeconomic demon will be a spectacular rise in food prices.


Agflation will define the future of the region to a far greater degree than illusory hopes for a GCC monetary union, Arab League diplomatic platitudes or demographic time bombs everywhere from Iran to the Maghreb. Yet myriad forces define the supply and demand equations of agflation. As in crude oil, iron ore, nickel and steel, Chinese demand has surged for soyabeans, where the Middle Kingdom already accounts for 26 per cent of global consumption. The world’s inventories of grain, corn and edible oil are at historic lows and, just like gold and crude oil in 2003, spectacular bull markets in soft commodities have been ignited. Political chicanery has been the DNA of agflation in modern times. The Iraq war and $100 crude oil forced the Bush White House and the EU to anoint biofuels as the path to energy independence from Arab oil. As US corn, protected by price subsidies and mandation, monopolised arable land, soybean and cotton production will plunge.

Agflation will change international politics, redefine economic models and trigger regime changes across the emerging markets. Far more than crude oil or even bullion, price rises in the supermarket trigger mass consumer inflation psychology. So central bankers at the Fed, the ECB, the Bank of Japan, RBI, PBOC and SAMA will be powerless to prevent food prices from accelerating the embryonic global inflation nightmare. Global warming, the destruction of the rain forest, carbon emissions and black swan (rare high impact events with fat statistical tail) events like Mad cow’s disease, avian flu and Australian droughts will make agflation as compelling a global issue, at Davos or the UN, as climate change.

Inflation in Dubai is as visceral as “stickershock” in Spinneys and Carrefour as in the price surge in white hot developments like the DIFC or Business Bay. Inflation psychology aside, agflation hits the poor like a financial neutron bomb and encourages hoarding behaviour that make price spirals a self fulfilling prophecy. As agflation accelerates, countries with farmland like Russia, Argentina, Ukraine, Australia and Brazil will possess a new currency of geopolitical power. While soybean and corn are as supply elastic in the short run as black gold, making price rises inevitable. Chinese pork prices, half the CPI for a staple diet for more than a billion people, surged and sparked worker riots and wage rise demands even in the high growth coastal provinces. The surge in the price of beef and tofu in Indonesia led to protests and compelled a cabinet minister to warn of potential social unrest similar to 1965, the fabled year of living dangerously when General Suharto overthrew President Sukarno and the Indonesian military massacred 500,000 suspected communists. Australia’s drought, Brazil’s bad harvests, Russia and Ukraine’s export restrictions and soaring global demand has lead to epic rises in the price of wheat. The surging price of kerosene, cooking oil and flour were instrumental in bringing down Pakistani President Musharraf’s PML-Q, the ostensible king’s party now reduced to a pitiful toothless dictator party. Indonesia’s sovereign creditworthiness is at stake because of agflation since Jakarta spends a third of its budget on fuel/and electricity subsidies.

Egypt is most at risk in the Arab world by the nightmare of agflation. Bread has been subsidised by the rulers of Egypt for millennia from Pharonic times down to the government of President Mubarak. Basic food prices have surged on strikes, bringing factories and universities to a halt. After all, “IMF bread riots” preceded the violence and unrest in the early 1990’s that culminated in the assassination of Anwar Sadat at a military parade to commemorate the 1973 October War. Even though the Egyptian government subsidises sugar, rice, oil and bread, food price surges are more of a threat to regime stability than Dr Zawahiri’s Al Qaeda terrorists. Bread queues turn violent, a recurrent theme in Egyptian history from Ramses II to the Mamluk sultans, from the Ottoman pasha rule to Lord Cromer’s British viceroyalty, from King Farouk to Nasser, Sadat to Mubarak.

The price of rice is the most accurate gauge of social stability for almost three billion Asians. Since Egypt, India and Vietnam banned exports to bring down local prices, the global price of rice has skyrocketed. If India restricts Basmati rice exports, a worldwide panic is inevitable. I believe Thai rice will prove a far bigger money maker for investors than Saudi sour crude. As rice prices double, the poor of Southeast Asia will go ballistic, threatening the government of countries like the Philippines, Burma and Vietnam. With water scarce, low investment in agriculture and dependence on imported food is a disaster for the Arab world.

As hedge funds speculate in coffee, the incomes of Brazilian farmers and Coorgi yuppies surge and the price of a Starbucks cappuccino became an inflation indicator in Ibn Batuta Mall. Stock exchange rumours swirl that Nestle and Kraft Food (owners of the Maxwell House brand) have not hedged their wholesale prices for robusta and arabica beans. I grew up in a world where the CRB, the world’s commodities index, correlated perfectly with global economic growth. The correlation, unfortunately, has broken down as the world flirts with recession even as food prices skyrocket. This is the stagflation and supply shock scenario, as in the 1970’s.

Agflation concerns UAE economic policymakers. The UAE economy minister is considering food price reserves to combat inflation. This was also the message of the government’s decision to freeze 18 basic foodstuff prices on 2007 levels. Will the UAE government follow rent caps with price freezes at private supermarkets? Food subsidies could even compensate for the decision by GCC central banks not to revalue their currency or drop the dollar peg, the symbol of the Gulf’s Washington security and diplomatic umbrella. Agflation, I am convinced, will be world history’s next game changer, an ominous sword of Damocles over the poorest citizens of the global village.

Matein Khalid is a Dubai-based investment banker and economic analyst

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