Should We Worry About Extreme Weather Causing Inflated Food Costs?

The cost of buying food is going up. The food-at-home Consumer Price Index (CPI) increased 4.8% in 2011. One of the factors that led to higher food prices was the weird weather. Not only was the U.S. hit with extensive flooding in the Midwest and drought in the Southwest, but changing precipitation patterns and mounting water stress cut into food production around the world.

The weather has gotten even weirder in 2012 and may lead to even bigger increases in food costs this year. The European cold snap is likely to reduce the continent's soft wheat crop by about 5%. Officials in Texas cut off irrigation water to rice farmers downstream of reservoirs depleted by the worst one-year drought in Texas history. It is the first time in its seventy-eight year history that the Lower Colorado River Authority has cut off water to farmers. In California, only 50 percent of the water requested from the State Water Project is expected to be delivered to nearly one million acres of irrigated farmland due to the lack of snow this winter.

So the question becomes, are the spate of floods and droughts just a fluke, or is extreme weather going to get worse? According to a couple of theories, the droughts and flooding are being caused by aspects of global climate change.

1) research by Jennifer Francis and Steve Vavrus suggests that warming in the Arctic is causing weather patterns in mid-latitudes to become more persistent. This persistence can lead to conditions like heat waves, cold spells, drought, flooding, and heavy snows. The researchers found that as temperatures in the Arctic warm and become closer to temperatures in lower latitudes, the waves of the jet stream tend to spread out, and west-to-east winds slow down in the upper level of the atmosphere (where storm tracks form). Both of these effects tend to slow the progression of weather patterns, which means that a weather pattern, whether hot or cold, is more likely to stick around.

2) A 4% increase in atmospheric moisture has been observed and is consistent with a warming climate.⁷ The increased moisture in the atmosphere is driving the shift to heavier but less frequent rains — “when it rains, it pours.” While an atmosphere that holds more moisture has greater potential to produce heavier precipitation, precipitation events also become less frequent and shorter, as it takes longer to recharge the atmosphere with moisture.⁹ By analogy, a larger bucket holds and dumps more water, but takes longer to refill.

If the above theories are correct, then it seems likely that the balance of 2012 will continue to feature extreme weather events. An increase in droughts and flooding would lead to further agricultural losses. And the increase in weird weather may be a long term problem. If extreme weather leads to food shortages in future years, big increases in the cost of food could become a serious problem. Thus, it seems appropriate to worry about extreme weather inflating the cost of buying food.

Deficits Must Not Matter -- U.S. Treasuries and Japanese Yen Both Rallying

The decline in U.S. stock prices and the increase in interest rates for the sovereign debt of Spain and Italy are getting most of the headlines today. However, it is noteworthy that the U.S. Treasury Bonds and the Japanese Yen are both rallying. The interest rate on the 10 year Treasury note dropped back below 2.0%. The Japanese Yen continued it's rally versus the U.S. dollar and closed at $0.807, a 4% jump in the past three weeks.

At least for now, traders are certainly complacent about the huge U.S. and Japanese deficits. The fact that the U.S. and Japan are projected to run the largest deficits as a percent of GDP among all world's developed countries is obviously not scaring off traders. As shown below, the deficits in the U.S. and Japan in 2012 are projected to be 9.3% and 8.9% of total GDP respectively.

Neither the U.S. nor Japan are taking any measures that will put a dent in their deficits in 2012. While continuing to run up massive deficits may lead both countries to fall off a fiscal cliff within the next few years, they obviously are considered safer haven than Europe.

Ultimately the huge deficits the U.S. and Japan are running up will matter. But given that the consequences of  unsustainable deficits may not wreck its fiscal havoc for a number of years, and traders have a very short time frame, deficits of countries that control their own currencies do not matter much for now in the bond and currency markets.

When Will Romney Slam Obama For Trillion Dollar Deficits?

The attacks that Mitt Romney has taken at President Obama so far have been no more damaging than the light jabs that fighters sometimes throw early in a boxing match. However, there is a purpose to boxers' jabs. They are using them to explore for opportunities and set up an opponent for bigger blows later in the fight. In the case of Mitt Romney, his lame attacks on Barack Obama are due to the fact that he is a weak campaigner.

Here is a message for Romney -- explain to American voters the dangers of four more years of trillion dollar deficits that a second term Obama administration would bring. Stop being so wishy washy and use justified fear mongering. The current Romney message is not connecting with voters. Romney is never going to be able to pull off a positive message the way the Ronald Reagan could. Yes, American voters would like an upbeat "shining city on a hill message", but Romney is not a strong enough campaigner to make it work for him.

The Romney campaign should go back and review tapes of Ross Perot's campaign. It is remarkable to recall that back in June, 1992, Ross Perot led the presidential popularity polls with support from 39% of respondents (versus 31% for Bush and 25% for Clinton). While part of Perot's appeal was his populist anti-establishment message, his core platform was the need for an end to U.S deficit spending. In hindsight, it seems almost hard to believe that one of his campaign infomercials drew 10.5 million viewers for a message that was loaded with economic statistics. 

The U.S. debt crisis is far more severe in 2012 than it was in 1992. There should be a lesson for U.S politicians from the popularity gained by Ross Perot. His use of charts to explain the dangers of the growing U.S. debt made the deficit math easy to understand.  And once U.S. voters understood the problem and the fact that Perot stood to address it, he gained widespread support from both conservatives and liberals. Given the incredible missteps of Perot's campaign, including dropping out of the race and then jumping back in, it seems shocking that he still ultimately received 19% of the vote on election day.

Illustrating the dangers of an Obama administration running up the U.S debt up to $20 billion during the next four years is a powerful campaign message. It is time for Romney to start using some justified fear mongering. The American voters need to understand what is at stake in this election. So far, Mitt Romney has failed to give voters a persuasive reason to vote for him. Romney needs move beyond weak jabs along the lines of Obama being "anti-business, anti-investment and anti-jobs" and start throwing some powerful uppercuts.

 

Why Are Gasoline Prices So High? The Japanese Nuke Shut Down Is A Contributing Factor

The high price of gasoline in the U.S. is primarily due to the high cost of oil. While there are many causes for the high cost of oil, a key factor is oil traders requiring a premium price for orders for oil in a market that is experiencing increasing demand amid concerns about supply disruptions. 

The demand for oil has been increasing in Asia as economies grow and car ownership becomes more commonplace. China has already surpassed the U.S. as the world's largest car market. The market for new car sales in India has also grown, to the point where it now is over a quarter the size of the U.S. market.

However, in addition to steady growing demand for oil throughout Asia, there has been a sharp spike in demand for oil from Japan due to shutting down nuclear power plants. Since the March 11, 2011 earthquake and tsunami that wrecked three reactors at the Fukushima plant northeast of Tokyo, Japan has shut down all but one of its 54 nuclear power plants. The country relied on nuclear sources for almost 30 percent of its electricity before the disaster. Japan has increased its oil imports for power generation by about 275,000 barrels a day .

It would be an overstatement to conclude that incremental demand from Japan of 275,000 barrels a day of oil was a primary cause of the increase in oil prices. This incremental demand only represents a fraction of the 90,000,000 billion barrels a day consumed world wide. However, it is a contributing factor to the tight supply of oil.

The Japanese economy was struggling before the tsunami hit north of Tokyo. The extra cost of importing 275,000 barrel of oil per day is one of the factors the converted the country from being an exporting powerhouse into a net importer during January, 2012. Time will tell whether Japan decides to restart its nuclear plants, but if they do so, it may offer a bit of a relief from today's high gasoline prices.

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Will The Standard of Living of Our Children Decline Due To Profligate Spending and Depletion of Resources?

I got into a debate the other day about whether our children will experience a declining standard of living. My opinion is that the standard of living in the U.S. for our descendants is going to be significantly below current levels due to: 1) massive government debt; 2) underfunded pension and medical obligations, 3) an ageing population; 4) resource depletion; 5) extreme weather.

Regardless of whether my bleak view of the future is accurate, I find the complacency regarding the risks of the economy heading off a cliff to be inexplicable. The U.S. economy may muddle through for the next few years, but the fact that our profligate behavior is creating so much risk for our children is concerning. If the World War II generation was the “greatest generation”, will we be considered the “worst generation”.  I do not think it to be much of an exaggeration to consider our generation to be financial sociopaths. We continue to pile up government debt to support our lifestyles, while leaving the burden for future generations to pay off.

It seems highly likely that the U.S. will elect politicians in November that will continue to pile up trillion dollar annual deficits. At some point, the massive government deficit and debt will become unsustainable. Further, U.S. voters do not have the political will to address the coming Medicare crisis. The depth of the Medicare crisis is outlined in Mish’s post on the 2013 Budget Showdown.

The current frustration over the current high cost of gasoline may grow in intensity as the supply of cheap oil is depleted. While enough new sources of oil has and will be discovered such that we will not run out oil during this century, supply is tight and may get tighter. As the expensive of pumping and refining new sources of oil continues to go up, so will the price of gasoline.  Further, investment in clean energy simply produces electricity, it does not replace oil. I challenge anyone to remain complacent about the impact the cost of oil may have on the U.S economy after reading Global Oil Risks in the Early 21^st Century.  Oil is not the only resource that is being depleted. Aquifers are being depleted. The oceans are being over fished and becoming more acidic.

The more time that passes before U.S. voters address the fact that we are on a path toward an economic calamity, the harder it will be to avert the crisis. Given the current failure and total lack of political will to address hard economic choices, I fear the standard of living of our children will be substantially lower than what we have experienced. 

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Insane Interest Rates - Countries With 10 Year Bond Yields Lower Than Their Rate of Inflation

The Fed warned today that "inflation could rise temporarily because of the recent increase in oil and gasoline  prices." Given the likelihood of inflation increasing, it seems insane that the interest rate premium for 10 year U.S Treasuries is below the level of inflation. It is straight out of economics 101 that bond pricing includes

An inflation premium added to compensate for the expected loss of purchasing power;

thus, it is obvious that the U.S. bond market is being artificially manipulated to keep interest rates low. While the interest on the 10 Year Treasury did rise a bit today to 2.077% , the rate is still well below the 2.9% rate of inflation in the U.S.

However, as shown in the chart below, the U.S is just one of a number of countries with interest rates on sovereign debt that is below the rate of inflation, basically featuring negative real rates of return. The market with the most negative real rate of return is Hong Kong at -4.8%. The negative real rate of return in the U.S. is also surpassed by Singapore, the UK, Finland, and Denmark. (For reference, today's rise in the U.S. rate on the 10 year note is not reflected in the chart below)

Given that interest rates on sovereign debt is likely to revert back to levels above the rate of inflation at some point, and the world could be in for a nasty bout of inflation due to higher oil prices and money printing by central banks, it seem unlikely that the 10 year notes of the countries listed above will turn out to be good long term investments.

Proposing A $1 A Gallon Gas Tax Would Be Political Suicide, But Would It Be Good Policy?

Most car and truck drivers probably have a viscerally negative reaction to the idea of higher gas taxes. However, given the tightness of oil supplies and the massive budget deficit, this might be a tax that is appropriate. Reducing demand for oil would extend and conserve this resource for future use. As has been shown with tobacco taxes, behavior and consumption is influenced by price. Reduced demand for oil in the U.S. would make us less dependent on hostile foreign sources and reduce the number of dollars flowing out of this country. Further, increased oil drilling (drill baby drill) and reduced consumption are not incompatible. Both are required to eliminate the 9 million barrels of oil the U.S imports daily.

New technologies and newly discovered oil finds seem to have pushed back peak oil by a decade or so, but the world is running out of easy to find, easy to pump oil.  The cost of oil seems likely to be on a slow upward spiral as demand  from Asia increases and oil becomes increasingly expensive to find and pump. More leaks and spills seem likely as drilling takes place in hostile and fragile environments. 

The challenge of closing the budget deficit is illustrated by how little support a gas tax would engender. U.S. voters may approve of imposing increased taxes on the rich, but are unwilling to increase taxes that impact themselves. Cuts in entitlements are equally unpopular. Thus, the U.S. will continue to run up huge deficits for the foreseeable future. A gas tax would offer a long term benefit by preserving scarce oil resources, as well as reducing the budget deficit. However it has no chance of gaining support as long as U.S voters remain complacent about the deficit and the diminishing supply of cheap oil. Time will tell if our profligate behavior comes back to haunt us in the future.

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