Wednesday, January 19, 2011

Goldman Warns on Agricultural Commodity Inflation

Goldman's chief economist Andrew Tilton has put a report out on surging agriculture and livestock commodities and notes the following:
 Prices for food commodities have surged in recent months, with our Goldman Sachs Commodity Agriculture & Livestock index up 60% since its recent trough in mid-June 2010...

Higher food costs have yet to reach the retail level.  Our analysis suggests an average lag of seven months from commodity price changes to retail food price changes.  Typically, retail food prices move about one-tenth as much as commodity prices.  Of course, there is significant variation in both the time lag and the degree of pass-through in individual episodes...

If commodity prices held steady at current levels, we would expect to see consumer food inflation accelerate from roughly 1% over the past year to about 5% in mid-2011...

Commodity food costs are only a small portion of the final consumer prices of food. Even raw vegetables at the grocery store incorporate some labor and transportation costs associated with getting the product from the farm to the store shelf. Much of the food that consumers purchase has been processed considerably and packaged, adding further layers of cost. And the food CPI includes food served at restaurants, which incorporates further costs of service. All of these other costs generally move much less than commodity food prices, diluting the effect at the consumer level. As a rough rule of thumb, we find retail food prices move a bit less than one-tenth as much as our GSCI Agriculture & Livestock index...

Tilton has the commodity increase correct but he is missing a lot. He is looking at this as though climbing ag prices are an isolated situation. They are not. For example, he cites the transportation costs involved with vegetables, but oil prices are climbing also, which will certainly impact transportation. Tilton, further, does not identify the causes of this inflation, which in addition to the supply and demand dynamics of the food sector, also include changes in the demand to hold cash balances and Bernanke money supply increases. These latter two factors will impact other sectors of the economy as well.

Tilton, also, fails to understand the imputation factor, whereby, it is consumer demand that ultimately sets the price of capital and raw materials, and not the other way around. If commodity prices are climbing, it means there is ultimately increasing demand for the products. With money printing pretty much a global phenomena at this point, the money demand (both in dollars and other currencies) will continue to climb.

Bottom line: Tilton sees the ag inflation that is in front of him, but doesn't fully understand its causes and because he doesn't understand the causes he doesn't understand  the severe price inflation that will accelerate and ultimately engulf most of the U.S. economy.

(Goldman Reserach via Zero Hedge)

1 comment:

  1. This is even before some of the banks fully exploit their excess reserves. From what I can see in the earnings blitz, JP Morgan is relatively light on reserves and reported higher than expected earnings. Citigroup is heavy on reserves (150+ billion deposits and 50+ billion in Fed Funds) and disappointed expectations. Citigroup said it's going to have to put that cash to use. Bernancke better have an exit strategy ready for the improving credit situation.