Sigmund, Carl and Alfred

By David R. Kotok:

Suddenly food price inflation has become the premier hot topic. The media is now attuned to food issues including emerging market country riots.

In the US, the politicians are gearing up to castigate the speculators and blame everyone but themselves. They conveniently forget that they are the ones who passed the ethanol subsidy and they are the ones who appropriate taxpayer money to pay farmers not to grow crops. And so the political circus begins.

Notice how the three presidential candidates are silent on how the US ethanol subsidy has caused a food price explosion in grains. They avoid the issue of US policy starving many in the world. 1 billion very poor people sustain themselves on $1 or less a day. We have doubled the cost of their food. Ethanol directly impacted corn which, in turn, also drove up maize. In addition, the substitution of wheat and rice are not easily occurring because of crop issues and concomitant price inflation in those items. Well Cumberland is in the financial market and money management business. We eat food. We don’t grow it and we don’t process it. So let’s try to inject some serious monetary policy issues into this media hysteria and political cacophony.

In the mature countries, food is a minor portion of the price index. And some of the food costs originate from eating out and some come from food processing. Processed food cost is heavily dependent on the inputs which are non-food items. Labor, machinery, transportation and distribution all come in to play. So in the mature countries we see that the food price inflation may be topical and attention getting but it is not a crisis.

Also, the major mature countries are mostly in food surplus. In the US we are very efficient in running our agriculture enterprise. We actually pay farmers not to till their soil. This is dumb. It occurs only because of our sorrowful Congress who has learned how to bribe the farm belt for votes at the expense of the rest of us.

In the US food has a 14% weight in the consumer price index. Compare that with Canada at 17%, the Euro zone at 16%, England at 11% and Japan at 25%. Only Japan lacks the fullness of food self sufficiency. Sure, food price inflation is important. But it is not the most important issue in these major economies.

The reverse is true for the emerging markets. In some of them the food price component is as much as half the price index. In a few it is above half. Since many of these economies are open to some degree, the importation of food price inflation is hitting them particularly hard. Some are responding with tariff adjustments. Others have actually embargoed food exports. Of course they ultimately make matters worse when they restrict world trade and in the end all suffer because of this protectionism.

What about monetary policy?

Here is where it gets difficult. We will admittedly simplify now and we acknowledge to our critics that we know there are second order effects and are ignoring them to make our point. In our view, monetary policy cannot easily and directly address food price inflation when the source of the inflation is in the raw food commodity. This is also true for energy costs when the source is in the oil or natural gas. The whole concept of “core” inflation vs. total inflation originates in this notion that monetary policy should be directed at the price level changes it can affect.

Let’s get to the inflation problem in an emerging economy. Our example is imaginary for simplicity’s sake. But it reflects characteristics that are very similar to many countries and regions in the emerging markets of the world.

We developed this simple and theoretical case study and then sent it to a number of economist friends. We suggested that following facts: the economy in question is a small and open emerging market. The food price component is 50% of the price index and is inflating at 15%. The non-food component is inflating at 5%. Thus the overall index is inflating at 10%. In this small and open economy, the main items in the food component are based on maize; therefore, the US ethanol policy which has raised the corn priced has also pressured an increase in the maize price.

Suppose you are the governor of the central bank. You have to set your policy interest rate. Do you base that decision on overall inflation rate of 10% or on the core inflation rate of 5%? Or are you going to confront the food inflation rate of 15%. Let’s further assume that your economy is growing at a trend rate of 5% and all other aspects are in trend or neutral position. You have no negative output gap and no above trend pressures. Your only direct problem is what to do about inflation.

My economist friends who answered offered a suggested policy rate as low as 6% and as high as 13.5%. The answers were about equally divided and the respondents sample size is over 20. The distribution of answers was distinctly bi-modal. About half the answers were bunched in the lower range of 6%-8%; the other half were in the double digit area between 11% and 13.5%.

The divided views centered on whether or not to target food, ignore food, or blend policy. No one wanted to set the interest rate above the 15% food price inflation. Nearly all acknowledged that this central bank would have difficulty in communicating whatever it decided. Most respondents worried about changes in inflation expectations because of the complexity of this issue. Most believed the citizens in the country would not understand the monetary policy dynamics that led to the decision.

Some worried that setting the policy interest rate in double digits would impose a very high financing cost on the non-food portion of the economy and cause it to go into recession. They argued that the real (inflation-adjusted) rate of interest for that non-food half of the economy would be 7% or so. That would set the threshold of finance too high.

Others argued that the monetary policy expectation effect would cause the rate of inflation to accelerate if the policy rate was not set in double digits. They were willing to take the recession in the non-food area in order to keep inflation expectations under control. No one mentioned substitution effects. Perhaps that was overlooked. Or it may be because rice and wheat are not easy cultural substitutes and those grains are each experiencing their own price pressures.
In sum, almost two dozen folks with some monetary economics expertise were equally divided on this technical question. It is a question that impacts billions of citizens in this world and many countries, their governments, their currencies and, possibly, their political stability.

We do not know the correct answer. Our view would support the lower interest rate and we would focus on the non-food portion of the economy but we can argue the other side with equal vigor. For us a lot would depend on how the food price inflation spreads into wages and if it could trigger a broader wage/price spiral.

In many respects this question is now being asked of the major and mature economy central banks as well.  It appears that the European Central Bank (ECB) favors the higher mode while the US Federal Reserve is positioned in the lower one. For the emerging markets it appears that there is quite a mix of policy and that it is made more complicated by the management of each currency’s foreign exchange rate. In sum, our simple case study is actually quite complex when applied in the real world.

David R. Kotok, Chairman and Chief Investment Officer of Cumberland Advisors.

Yesterday, we wrote part one of From The Author Of SC&A: Plaza San Marco And Blog Wars, in which we discussed the recent flare up between some right of center bloggers.

We were going to publish the concluding and final post on the matter on Monday, but because of some of the emails we received, we decided to publish on the matter today.

We noted yesterday that, ‘Ideas are meant to provoke thought, not necessarily agreement.’

Unfortunately in just about every environment and discipline, personalities often obscure that truth. There are global warming scientists who take great umbrage at their peers who question their work and conclusions, there are politicians who will insist that evil cam be negotiated away and there are entire populations who will embrace dysfunction with open arms so as to avoid reality.  There are still others who will hold on to ideas long after they are disproved because they feel that somehow, they have been personally discredited. The same behavior can be found in the lesser disciplined blog world. Personalities often trump ideas when it comes to criticism or even the validity of ideas.

I have noted on more than one occasion that when the scientist who discovers a cure for cancer, the ‘Euruka!’ moment will not be the result of his work alone or his to claim as his own. The cure to cancer and other diseases will come about because of the failures of others. Every researcher who undertakes a study or research project that does not pan out, adds to the body of knowledge from which that the ‘Eureka!’ scientist will have learned. The efforts and direction he takes in his quest comes about as the result of those who preceded him. When it is all said and done, the cure to cancer will have been arrived at by the work of thousands of researchers. Scientists and researchers understand this. The reason there are so many professional journals is because they serve as an outlet for ideas that inform, educate and most importantly, build upon a body of knowledge and serve as a springboard for new ideas. Sometimes the published work becomes accepted science or medicine, sometimes that published research is disproved by other research. In all cases, the bodies of work of the various disciplines are enhanced.

Notwithstanding how the media plays the story or their need for heroes, the aforementioned is the truth about research and science, When personalities get in the way, objectivity gets tossed out the window and we are all the poorer for it.

Objecting or rejecting to an idea is not objecting to or rejecting an individual.

The authors of Gates of Vienna have certain ideas (many of which this writer agrees with, though not all) that they are passionate about. In Europe, those same ideas have found various political outlets and vehicles. The GOV have attached themselves to some of those vehicles and have come to represent those interests on this side of the Atlantic (whether they wanted to or not).

Predictably, there were those who were highly critical of the authors of the GOV. Some of the people associated with the movement to which they are aligned have less than stellar pasts and some have been aligned with the hard right these new groups wish to disassociate. That said, simply clicking their heels three times and wishing for their past associations to disappear isn’t a very good idea.

(It is here that I must point out that it is my belief that authors of GOV would never knowingly or willingly associate or align themselves with any group or individual they believed to be in the least bit xenophobic, racist or bigoted.)

The right to criticize or question to with ideas and groups with GOV have chosen to align themselves is inviolate. It is up to the GOV to present their case and argue their ideas. Even if and when the criticism becomes personal, their positions can only be strengthened by arguing their case and not responding to anything other than substantive critique.

When Michelle Malkin wrote the NYT bestseller In Defense of Internment, she was excoriated by a broad spectrum of the media and blogosphere. She did not respond to the visceral hatred (very few of whom actually read her book)- instead, she responded to the serious criticism of her work and she acquitted herself more than admirably. I also have no doubt that further editions will reflect ideas that she may want to revisit and she will do so fairly and honestly.

Had Malkin responded to those who made their attacks personal, she would have been the lesser for it.

The same can be said for GOV and those who attacked them. What started off as a disagreement of ideas quickly descended into a clash of personalities. Had the exchanges focused on substance and not on personalities, this ‘family feud’ would not have escalated into the bloodletting we all see.

Charles Johnson author of Little Green Footballs was correct to address the reality of the European hard right. The truth of the matter is that the hard right in Europe not only exists, but thrives. Reader Expat left a comment on our initial post. She writes and addresses the truth that Euro politics are not clear and dry cut. Neither GOV or Johnson can address the issues that face Europe, easily or glibly:

Just today there were neo-Nazi demonstrators at the May Day rallies in Hamburg and Nuremburg (about 1000 each). There were counter-rallies by normal people who reject their ideology, but there were also counter-rallies by leftist thugs looking for a fight. In the east, some towns have sizable neo-Nazi groups that the government is worried about. A lot of these people have been the losers of reunification who resent lost jobs and competition from immigrants. Some probably feel that they get less help from the government than the foreigners. I think there is also a sex imbalance because young women moved west. It is very complex. It should also be noted that far left ideology is also gaining ground.

One thing is certain: Amid all the left-right name calling, it is hard to discuss the problem of radical Islam at a level most of us would prefer, that is to say at a level that is productive. Two of the most focused in Germany are Seyran Ates and Necla Kelek, both of whom point out that glib multiculti slogans are not the way to go. They say that Germany has to stand up for womens rights and the democratic values.

If we want to save Europe from the same fate as Venice, name calling will only detract from the matter. The far European far right is no more a myth than is the European far left.

Sadly, it appears that parts of the right blogosphere are beginning to resemble the majority of the left blogosphere, a place where style upends substance and ‘pivot and attack’ are the response to questions or requests for discussion.

Criticism is not a zero sum game- it not an all or nothing proposition. We can criticize and disagree and still share core beliefs. To believe otherwise is to play the game the way the Democrats are in this presidential campaign. The hatred between Obama and Clinton is vicious and visceral and when the dust settles, no amount of sawdust will clean up the bloodbath. The same is true of this latest LGF-GOV dust up.

There is enough bad behavior here to go around. Both Johnson and the GOV have made accusations and counter accusations. Both have used projection and displacement on each and on anyone who happens to agree or disagree with them on any one point. Each of the protagonists seek to secure a certain victim status at the hands of the other and at times the exchanges have reached histrionic proportions.

In the end, even when there is but a hairsbreadth separating some on the right, this dust up has proved we can be just as petty and malevolent as those on the left, with equally as destructive consequences.

What a pity.