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The Nexus Of China, Cheap Dollars, Food Prices And Arab Revolt

The Nexus Of China, Cheap Dollars, Food Prices And Arab Revolt

All bets off on optimistic economic (and political) forecasts from the U.S. to Germany to China, as social unrest and inflation fears shake investors.

(gilles chiroleu)

BERLIN - It starts with a flood of dollar bills. Cheap US currency is causing a sharp rise in commodity prices, with food affected even more than oil.

 Global increases in living costs are releasing waves of hunger, rage and revolution. Poorer countries are being hit hard by inflation. Those responsible for the money glut are sitting in Washington.

It's becoming clear that 2011 could turn out very differently than forecasters' predictions. For stock market players, this means more unpredictability and susceptibility to heavy losses. Up until now, German forecasters have been pointing to the strong national economy and bullish corporate profits, prompting predictions that the German stock index DAX will soar to 8000 points or more by the end of the year, against current levels of around 7000 points.

But two recent developments may be set to shatter German analysts' optimistic consensus – and both of them relate to the run on commodities. Firstly, the flames of the Arab revolution have now reached a major oil producing country, Libya. Secondly, in a development that should cause analysts' ears to prick up even more than the first: the online calls for protest have now reached China. The world's second largest economy, China is also the most important growth engine for many top German companies.

Of course oil is still probably the single most important commodity for the world economy, and rising prices are meaning investors are less willing to part with their money. Libya is Africa's largest oil-producing country, and Germany's third largest supplier. 

So far the developments in Libya and China are only causing worry lines on the brows of a few stockbrokers who have been counting on a robust recovery. After all, the DAX has risen 1500 points since last autumn.

"Up to half of all overall global economic growth in the next ten years will come from China," says Guido Lingnau, portfolio manager at Guliver Financial Advisory Services in Berlin. For years, the money manager has aligned his investment policy according to the likelihood of social crises. He sees the potential toppling of the Chinese superpower economy as the single greatest threat to global financial markets.

Overall, the global economy is far more vulnerable to shocks than many optimists are willing to accept. Money flow is the culprit. With their policy of cheap dollars, euros, pounds and yen, the world's major central banks have helped to ensure the financial crisis of 2008 has not developed into a second Great Depression. But the policy has also sown the seeds of a new gathering crisis. Cheap liquidity is flowing around the globe and driving up all kinds of commodity prices. These rapid price increases are threatening to shake the global capital markets to their core. 

Particularly dramatic is the increase in the price of agricultural commodities. "Agricultural goods are also subject to other factors, not least the growth in world population and prosperity in emerging countries," says Lingnau. Both trends are driving up demand for high quality food. Declines in harvests due to climatic factors – such as those recently seen in Russia and Australia – can't be easily compensated for.

Since the beginning of last year alone, the price of cotton has risen by an alarming 161 percent, coffee by 99 percent and pork by 41 percent. Most critical, however, are agricultural commodities from which staples such as bread or tortilla (in Latin America) are made. The price of corn is now 72 percent higher and wheat 51 percent more expensive than in early 2010.

The rise in foods prices is having a dangerous affect on geopolitics. It was rage over the price of wheat and bread which first triggered the current revolutions in North Africa. Societies in emerging countries are far more vulnerable to food price shocks than those in industrialized nations. Whilst food and drink only make up a small share of the average European's shopping cart, for citizens of emerging countries it can be up to 50 percent.

Popular uprisings in the Arab world could trigger a new spiral of inflation. A change in government won't solve food shortages. On the contrary, in the short term, the uncertainty is more likely to mean that existing grain is hoarded and prices rise even further.

And the situation is getting worse. Increasing numbers of investors are reacting to geopolitical uncertainty by transferring their capital into hard assets. Gold, silver, and even oil to some extent are the traditional refuges for investors during times of aversion to paper money. Recent days have not only seen stark increases in the price of energy, but also the costs of gold and silver. A troy ounce (31.1 grams) of gold cost $1,407 as the week opened, a level hovering around $15 below its all-time high. The price of silver rose to $33.98, its highest level since the beginning of the 1980s.

Rising food costs are unsettling stockbrokers and confronting central banks with a terrible dilemma. They must now raise interest rates to counteract inflation. But given the weakness of the financial sector and the structural problems in many industrialized countries, they are understandably reluctant to do so. Financial guardians and politicians can only pray that several years of good weather will provide rich harvests, which would allow agricultural prices to ease and might provide relief to the tense global situation.

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