Why are food prices increasing?

Gonzalo Baranda from Investment Marketing at JPMorgan Asset Management explains: "There are several reasons. On the supply side poor harvests due to adverse weather conditions and decreasing growth in productivity have not been able to cope with the increase in demand.

On the other side, demand has been affected by long-term trends; an increasing world population and a change in consumption patterns in rapidly growing emerging markets with, for instance, an increase in the consumption of meat. However, demand has also been altered by powerful short-term factors. One is the growth in demand for heavily subsidised biofuels, which have especially affected the price of corn, soybean and other crops competing for the same cultivable land. More recently, however, we've seen massive interest from many investors in an asset class which offers some protection against a falling dollar".

What are some of the current and future consequences?

It has huge social implications. As Engels stated in the 19th century: "the poorer a family is the greater the proportion of total expenditure which it must spend/use to procure food". This statement still applies today. While in the US, less than 10% of total household expenditure is dedicated to food, it is more than 25% in countries such as Mexico or Russia. As food inflation keeps increasing this will likely create further unrest on two fronts; potential riots from poor people demanding access to affordable basic food as happened in Haiti, bringing down the government, and farmers opposing higher export tariffs, highlighted by their actions in Argentina.

On a macro level the implications are already being felt around the world, through higher inflation at a time of slowing growth. In addition, if inflation expectations increase, a wage-price spiral could ensue which explains the recurrent warnings of the ECB to control wage hikes. The trade balances of commodity exporting countries will keep increasing, which will likely accelerate the appreciation of their currencies. Currencies like the Australian dollar or Brazilian real will face further upward pressure. In contrast, external balances of net commodity importers will deteriorate.

Protectionism will increase. Most governments have always tried to control food supply through border tariffs and grain storage systems and this trend will increase as they try to guarantee the supply of basic food. China, for instance, has already announced an increase in export duties for fertilisers and has curbed exports on rice.

The political debate on biofuels will intensify. Governments, especially the in the EU, are likely to reduce their biofuel production targets. However, with biofuels representing an increasing percentage of the new sources of energy, a drastic cut in production could lead to more expensive oil. This would feed back into higher food prices through higher fertiliser and diesel prices, completing the vicious circle.

Nuclear energy will be back in fashion and new technologies to produce second-generation biofuels based on non-food products will be promoted. More genetically modified, insect-protected or herbicide-tolerant crops will be introduced to raise supply.

Eventually, supply will be increased as more land is put to work and productivity improves. However, this will take some time as inventories are currently very low and more institutional investors are entering the market. Prices will stay highly volatile yet for a while longer.