Drought Fallout Could Range From Inflation To Regime Change


Hungry people standing in bread lines start revolutions: France in 1789, Russia in 1917, Egypt in 2011. That fact must make certain regimes around the world uneasy as the global drought now unfolding causes crops to fail and grain prices to surge. For everyone else, higher food prices are in store and a return to global inflation looms.

In the United States, the world’s largest grain exporter, a warm spring encouraged early planting and predictions of record crops. Instead, the hot summer is now scorching the country’s farmland. The last 12 months have been the hottest since the US started keeping records in 1895. According to the US Drought Monitor, 53% of the country is experiencing drought conditions, the most since 1956. The US Department of Agriculture has already cut its corn crop forecast by 12%.

Globally, land temperatures are now the highest on record. According to the Global Drought Monitor, severe conditions extend from the US and into Canada; reach across much of central Africa, India, Europe, and central Asia; and affect parts of Australia and South America. The International Grains Council recently cut its global forecast, particularly for wheat.

The worldwide drought has already pushed corn futures up 56% since the start of June. Wheat is close behind, jumping nearly 40%. Soybeans recently hit a new record high. Barley, rice, rapeseed, and other grain prices are also up.

The spike in grain prices is beginning to spill over into the broader economy. US ranchers are reducing their cattle herds because of the higher feed costs, which eventually will mean higher meat prices. Restaurants and food packaging companies could see their thin margins squeezed even tighter. If sustained, the pass-through of higher food prices will also show up in the general price level, complicating policy options for central bankers currently accustomed to benign inflation.

The implications are especially challenging for emerging markets, where food has a larger weight in consumer prices indexes. Low inflation has provided room for interest rate cuts to spur growth in many countries. Higher prices could take away that room for manoeuvre and even force a policy reversal. China, in particular, could be in for a rude shock in the months ahead, just in time for their leadership transition in the fall.

This is now the third surge in grain prices in five years. In 2007-08, food riots broke out in more than 30 countries. In 2010, many governments began to restrict exports. When Russia suspended supplies to Egypt, soaring food costs subsequently helped set the stage for what turned into the Arab Spring. So far, global inventories are holding up, but the year is barely half over and no one knows just when the drought will end. Higher grain prices can cause inflation. Food shortages cause regime change.

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