Exchange Rate Regimes and Soaring Food Prices

♠ Posted by Emmanuel in at 5/06/2011 12:02:00 AM
While some would argue that America's unrepentant salvo of free money is a significant driving force behind food inflation worldwide (yours truly included), the Food and Agriculture Organization (FAO) has a more nuanced explanation. Even providing that the currency in which most foodstuffs are denominated in is on a long-term downward trend, today's market gyrations notwithstanding, the particular foreign exchange regime a country adopts as well as its status as a net food exporter/importer helps determine how well it copes with global price rises. To de facto peg or not to peg, and to the dollar or the euro? Hamlet never had it so easy compared to the decisions LDCs are faced with in this day and age. The following is taken from the FAO's Initiative on Soaring Food Prices - Guide for Policy and Programmatic Actions at Country Level to Address High Food Prices:

Meanwhile, here are some key talking points from the report:
There is emerging consensus that the global food system is becoming more vulnerable and susceptible to episodes of extreme price volatility. As markets are increasingly integrated in the world economy shocks in the international arena can now transpire and propagate to domestic markets much quicker than before.

Increased vulnerability is being triggered by an apparent increase in extreme weather events and a dependence on new exporting zones, where harvest outcomes are prone to weather vagaries; a greater reliance on international trade to meet food needs at the expense of stock holding; a growing demand for food commodities from other sectors, especially energy; and a faster transmission of macroeconomic factors onto commodity markets, including exchange rate volatility and monetary policy shifts, such as changing interest rate regimes.

What is more, financial firms are progressively investing in commodity derivatives as a portfolio hedge since returns in the commodity sector seem uncorrelated with returns to other assets. While this ‘financialisation of commodities’ is generally not viewed as the source of price turbulence, evidence suggests that trading in futures markets may have amplified volatility in the short term.
So aside from the helicopter dropping of dollars, we also have to contend with more extreme weather conditions (implicating global warming), the globalization of agricultural markets, commodity speculation, and the diversion of foodstuffs to biofuels. It certainly doesn't look like a promising scenario as far as food prices are concerned, making it imperative to study the link between FX regime and food prices.