Ethanol – Inflation

| April 16, 2007 | 0 Comments

Food.  Like clockwork you and I sit down to 3 and sometimes more meals every day.  The desire to feed our rumbling bellies is intuitive.  You don’t need to think about being hungry, just like you don’t need to think to have your heart beat!  As I sat down to dinner last night at a restaurant I started thinking about the little things – how my meal impacts the stock market?

An interesting question no doubt, and as I started to think about it more and more, I realized my very meal will have a much longer term impact on my finances – far in excess of the bill I have to pay at the end of the night.  Now, ask yourself, “How is dinner going to impact the markets?”  Let me show you.

As you are probably aware the global economy is booming, and this is putting demands on every part of the economy.  In emerging economies like China and India, you are seeing an emerging middle class who is craving the visibility of success of most western nations – automobiles, air conditioning, electricity, and copious amounts of food!  Simple demands with dramatic impacts.

Energy is a staple of every developed country, and with it comes a cost.  No matter the source- sun, wind, hydroelectric, natural gas, or even coal. The demands of these developing countries are driving the cost of oil (and other energy bearing commodities for that matter) up on a global basis.  This is creating an interest in other forms of energy – enter ethanol and biodiesel.

Now the focus on these alternative energies is having some unintended consequences – ethanol and biodiesel is produced from agricultural products – corn, palm oil, soybean oil, and sugar just to name a few.  The Wall Street Journal noted that it is estimated that 30% of the US grain harvest will be devoted to ethanol production NEXT year!

With so much of the agricultural economy focused on “alternative energy” production, the supply of these needed staples is bound to fall, subsequently driving up prices, and with increased prices of staples we bump into a little friend of ours – inflation.

Inflation.  A simple little word with tremendous impact on the global economy, individual countries, companies, and you and I as the consumer.  This surge in food prices is due to imbalances in supply and demand – too much demand too little supply.  Traditionally, rising food prices were caused by a short term impact from weather, however, food prices are now seen as a very real threat to some economies.

Food accounts for substantial portions of the consumer budget in emerging economies.  For example, according to the CPI index in the United States, food accounts for about 15% in Thailand it’s 35% and in the Philippines its 50%.  People need to feed themselves so they cut back on other areas of spending.  The cost of employing people goes up, subsequently rising the cost to produce other consumer goods.  This is known as inflation my friends and if it gets out of hand it can be deadly.  Germany suffered dramatic bouts of inflation prior to WWII and while not the only cause, it was a substantial contributor to the war!

The respective governments of the world recognize the potential impact that inflation can have on their economies.  To counteract the inflationary nature of things, the number one solution is raising interest rates which keeps inflation in check but wrecks havoc on the equity markets.  With sustained increases in food prices in these emerging economies, the governments are most likely to increase interest rates and negatively impact world markets.  We all know the impact the Chinese market now has on the US market!

Remember tonight’s dinner may be costlier in more ways than the most obvious.  Expect to pay more for your steak (another consequence of rising corn prices) and watch out for tumbling international markets . . . all caused by the food that you eat!

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Category: Commodities

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The Dynamic Wealth Report works with a number of staff writers and guest experts who specialize in everything from penny stocks to ETFs to options trading. These guest analysts post under the 'staff writer' moniker for ease of use.

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