Coinflation

I vaguely remember when pennies became worth less than the copper they contained; via MR, the same condition has spread to the nickel and beyond:

US five cent coins contain over 7 cents worth of raw material as of this afternoon, mostly copper and of course, nickel. If there is inflation, the prices of metal will increase, and the coin will have 8, 9, 10 cents worth of metal. Pre-1965 dimes contain over $2.42 of metal today, while pre-1965 quarters have over $6 worth of metal.

I wonder what they did to dimes and quarters after 1965, and whether the same is in store for the nickel. (While the penny, of course, should just be abolished.)

Commodity price passthrough, cotton edition

Here are some excerpts of alarmist journalism from the NYT:

A package of Oscar Mayer cold cuts. A pair of Nine West boots. A Whirlpool washing machine.

By the fall, people will most likely be paying more for each of them, as rising prices hit most consumer goods...

After trying to keep retail prices flat or even lower during the recession, Jones says prices for its brands will climb 15 to 20 percent by autumn.

... and here is Michael Roberts appropriately skewering that alarmist journalism.

Yesterday the near month futures price of cotton closed at $1.83/lb. That's pretty high, more than double the price of just a year ago. Before this year, I'm not sure [nominal] cotton prices ever exceeded $1.20...

How much do these high prices matter for the prices we pay for clothes?

Not so much. Consider that there is about 0.6 lbs. of cotton in a typical man's shirt. So that $1/lb increase in cotton prices over the past year means it costs an extra 60 cents to make the Brooks Brothers shirt for which I paid $40. On sale.

That should sound pretty familiar to regular readers who have seen the same trick with food prices.

Passing off 15-20% price increases as cost-driven when they are demonstrably not (at least for raw inputs) seems pretty risky and short-sighted. I can't speak much to the rest of the cost structure, although we are not exactly in a tight labor market in the U.S. either.

Picture of the Day: World of Snow and Ice

Via Tyler Cowen. This picture is a few days old. A reminder of how naturally variable weather can be (and thus how hard things like climate change are to track).

Better energy storage?

Via Geoff Styles, a very intriguing idea: Windfuels, i.e. "storing wind power in gasoline."

Doty Windfuels has been working on a system called RFTS, or Renewable Fischer Tropsch Synthesis. The process looks to use off-peak excess wind energy to recycle CO2 into standard fuels that work seamlessly in the one billion cars and trucks on the road around the world. The chemistry is fundamentally simple and well understood.

Geoff doesn't seem all that enamored of the idea (put off in part, he admits, by the inventor's excessive negativity toward seemingly all other energy alternatives). I'm a bit more positive. There's a lot to be said for building almost entirely on proven technologies (in this case, chemical pathways; the only step not commercialized is reducing CO2 to CO). Even if the economics get worse as other energy storage technologies like CAES begin to compete up the price of off-peak electric power, it certainly wouldn't be a bad thing for there to be one more storage technology in the mix. And even if this specific idea doesn't bear fruit, it encourages further investigation of storing off-peak power as chemical energy (rather than mechanical, e.g. compressed air, or thermal, e.g. molten salt), an avenue I hadn't thought of much, and one which makes a lot of intuitive sense.

Watch the crush spread

Trying to chase down cause and effect in energy and resource markets can be frustrating - it is hard to follow a linear path to a new, coherent equilibrium. Take, for example, Geoff Styles' recent line of thought on the impact of Egyptian unrest on renewable energy.

... since the protests started on January 25, and without any actual disruption in oil deliveries, the price of UK Brent crude... has climbed by around $5 per barrel and now trades solidly above $100.

... [Ethanol and biodiesel] stand to gain if oil prices are driven up by factors that don't also push up the prices of the commodities from which they're made [emphasis mine].

That last bit is critical, and can't be taken for granted. In late 2008 ethanol was clearly the marginal use of corn and corn became priced off of its value in use as ethanol, squeezing margins despite high oil prices. If biofuels come back in a big way, this dynamic is likely to kick in (leading, incidentally, to even higher food prices, not good for most people).

Who are the real cotton speculators?

The WSJ (and the InterContinental Exchange, for that matter) always seem so quick to jump on financial speculators as the cause of price rises in any given commodity. Cotton prices more than doubled from Dec 2009 to Dec 2010, and have risen another 20% in 2011.

The top cotton-futures exchange is clamping down on speculation amid soaring demand that has sent prices up, threatening losses for mills, commodity merchants and apparel producers.

... Over the past year, the number of cotton contracts outstanding has grown by 21%, aided by an influx of hedge funds and small speculators.

ICE is apparently worried, although I can't tell how much of this is journalistic dramatization.

In response, ICE on Thursday said it will increase its scrutiny of big positions from now on.

"Increase its scrutiny," huh? A pretty threatening step!

A few maxims for analyzing commodity price spikes. First, always look to supply and demand first. Second, as Paul Krugman reminds us, speculators can't sustainably increase prices without actually withholding physical supply from the market, so if inventories aren't increasing, be skeptical.

What do we find in this case? First, the supply-demand picture looks tight, as the WSJ itself acknowledges:

Low global stocks of cotton and growing demand, particularly from China, have caused concerns of shortfall in the fiber this year. Rains in Pakistan and India, the second-biggest grower, and recent floods in Australia have fed fears of a shortage.

Second, there is actually cotton hoarding going on at scale - by cotton farmers in China (via Krugman). That is physical speculation (seems morally reasonable when it's farmers doing it, and incidentally not subject to ICE position limits). Finally, political uncertainty makes commodity markets jittery, and Egypt is a major cotton exporter. I think there might be something going on there.

P.S. Egypt is indeed a major cotton exporter, but I was surprised to learn that in 2004, Benin, Mali, Syria, and Greece exported comparable volumes, and FAPRI doesn't even track Egypt for cotton. Based on price per ton from FAOSTAT, Egyptians do the high-end stuff.

Chicken meat discrimination

Via John Durant, I never thought to wonder what happens to all the dark meat?

There's no question that Americans overwhelmingly prefer white chicken meat to dark. We eat chicken almost 10 times a month on average... but on less than two of those occasions do we choose chicken legs, thighs, or drumsticks.

The historical answer is: to Russia.

... in the 1980s, when chicken consumption in the United States increased at a phenomenal rate, the poultry industry needed new outlets to absorb the growing numbers of discarded legs.

It was most fortuitous, then, that the Soviet Union collapsed in 1991, resulting in the relaxation of trade restrictions that had hindered commerce with the formerly Communist state. U.S. chicken exporters, eager to exploit this fresh market, were able to underprice virtually all other animal protein produced in Russia, and American dark meat flooded the country. The chicken legs became so popular that locals endearingly nicknamed them "Bush legs," after President Bush Sr.

The complication now is that Russia seems determined to put up quality-related trade barriers (spurious, to hear American exporters tell the tale), so poultry producers need either a new market abroad, or a revolution in domestic tastes.

I've always preferred dark meat, so I'm raring to go to the grocery store and pick up some discounted bone-in chicken thighs. Although I wonder if they're apples-to-apples cheaper than the whole rotisserie chickens which are currently my favorite (and stupidly cheap compared to other types of meat).

Can't fix commodity prices with monetary policy

Paul Krugman has the more detailed version with his traditional lefty spin, but I'll go with Michael Roberts' synthesis...

Commodity price rises have little to do with monetary and currency policies in the US and around the world.

... and concise takeaway:

We'd be wise to think about possible collateral damage of higher commodity prices, since I suspect high prices could be here to stay. But this really should have no bearing on monetary policy.

It's pretty easy to verify with a quick look at oil prices over the past three years - the dollar didn't fall far enough to push crude up to $145/bbl, nor rise enough to push it back down to $40, nor fall again enough to get back to today's range of $90+.

Sure investment advice?

BlackRock CEO Larry Fink thinks agriculture and water will perform even better than energy:

"Go long agriculture and water and go to the beach," said Mr Fink, whose creation was now the biggest funds manager in the world, with $US3.5 trillion ($3.07 trillion) under management -- more than the GDP of Germany.

"Put those investments in the bottom drawer for 10 years. It's unlike anything else we have in the world."

Agriculture and water would even beat energy investments, he said.

"They're finding lots of ways to find new energy -- Israel's going to be an exporter of natural gas and I'm hearing there's more oil under Iraq than Saudi Arabia, for instance, although it's not secure."

This is probably right, although I have two caveats. First, it's hard to find a vehicle to use to go long on water. Second, I don't buy that it is so simple to prove that commodity prices will trend upward from their current level, as Matt Yglesias tries to do by saying that

Over the past ten years, catch-up growth in India, Brazil, and (especially) China has been the majority of world growth. Consequently, the rate of stuff-utilization is going up higher than the rate of stuff-production, meaning we’ll see rising commodity prices rather than falling ones.

There are real discontinuities in the supply and demand curves for commodities, and if it were that easy, none of us would have to work our day jobs.

I do agree with Yglesias, though, that the implications of rising commodity prices are decidedly not good for poor countries with stagnant growth. What's going down in Egypt looks very, very real.

P.S. From Felix Salmon, the good thing about Egypt is that the WEF fixed it.

Robot harvesting strawberries

It's been a while since I posted anything (since 2010, in fact). So, via Ben Casnocha, here's a YouTube video of a robot harvesting strawberries. Here's a short advocacy documentary on migrant workers harvesting strawberries in California (and our robot is nowhere near ready for those conditions). Here's the AP study demonstrating that unemployed Americans don't want this job (notwithstanding, of course, that white people like to pick their own fruit). And here's Parke Wilde on the agricultural economics of strawberries, or why weather matters and yet sob stories should be taken with a grain of salt.

The opposite of speculation

A lot of people complain about speculation in agricultural commodities as the root of all sorts of evils. But what does it look like when there’s no speculation at all?

The pork belly is in danger of going belly-up... just six contracts changed hands in the month of November—fewer than uranium or palm oil. The once-bustling pork-belly pit has been moved to a corner of the CME's floor, an appendage to the lean-hog-trading pit.

There are several reasons, but a big one is that

Financial traders have largely shunned the contract because it requires buyers to take possession of massive quantities of meat.

It seems even small-scale market participants appreciate this dynamic:

"For a contract to be successful, you have to have fund participation" from hedge funds and commodity funds, said Dan Norcini, an independent livestock trader in Idaho who has been trading commodities for more than 20 years. "There're not enough volumes for them to move in and move out." Mr. Norcini stopped trading pork bellies about three years ago.

The moral of the story, as usual, is that “speculators” provide liquidity and liquidity is by and large a good thing.

Surging commodities ≠ inflation?

Paul Krugman doesn't think surging commodity prices will drive high inflation (and Michael Roberts agrees). I think they're probably right on balance, but I wish Krugman had plotted year-on-year commodity price and CPI changes on different axes in this graph:

Yes, the magnitude of year-on-year changes as drastically different, but eye-balling it, the directional correlation looks pretty high to me. Granted commodities are a small fraction of the our rich-world expenditures (not the case in poor countries where people spend 50+% of their income on food!); they are mostly wages and rent as Michael correctly points out. But it would also be worth looking back to before 1993, in particular the late 70s (a time of high commodity prices and high inflation), rather than acting as if 15 years of data from a single country proves the point beyond a shadow of a doubt.

Styles 2010 energy round-up

Geoff Styles, as preeminent an energy blogger as there is, has a little round-up of 2010 in energy, which is worth reading in full (including links), so I won't paraphrase it exhaustively here. He comments that the two truly unforeseen and shaping events of the year were Deepwater Horizon and "the less spectacular but no less profound awakening to the possibilities of the shale gas revolution." His comment on shale gas is particularly insightful:

That might help explain why the developers of renewable electricity sources such as wind have struggled so much this year, despite receiving $3.9 billion in direct cash grants from the US Treasury. They're not competing with $90 oil; the US generated less than 1% of its electricity from petroleum this year, through September. Instead, they're competing with gas at an effective price of $25/bbl or less.

Here's the killer graph:
Shale gas really is a game-changer, but its continued rapid growth is not a foregone conclusion. The two massive unknowns that I will be watching closely in 2011 are the environmental impact (already much debated and increasingly feared), and how it evolves outside of North America - in previously gas-vulnerable Europe, and even more so in China, where the reserves are likely enormous and the government has the power to develop them rapidly, if desired.

With that, Merry Christmas to you and your loved ones, and I will get back to mine.

Sidling away from climate debate

While results from Cancun seem to warrant cautious optimism, it seems fewer and fewer actors want to tackle climate head-on in the U.S.:

After two years of fairly disappointing outcomes at the U.N. climate summits in Copenhagen and Cancun, and after watching hopes for cap-and-trade or other measures to regulate carbon fizzle in the U.S. Congress, a growing slice of those favoring investment in clean-energy are working hard to ditch the association with "climate," which now seems to many a losing political issue. As the Breakthrough Institute's Ted Nordhaus put it, "We need to free energy from the polarizing climate debate."

This seems like an obvious step, in retrospect, and potentially a very positive and effective one. After all, climate is only one form of environmental pressure humankind is exerting upon the planet, and there are many other (inter-related) challenges to tackle (water, waste, agricultural sustainability, etc.). And hey, if it worked in Kansas...

Ethanol subsidies live another year

NOOOOO!!! Despite promising earlier signs, the ethanol tax credit renewal managed to sneak into the tax bill, so it's been extended into 2011 at least. Very disappointing, even though Geoff Styles thinks the subsidy won't last past next year.

Cocoa corner appears to fail

Remember the great cocoa heist of 2010? Seems that good weather and a promising harvest in the Ivory Coast sunk the whole scheme, which is now being unwound. Hard to tell outside-in how Armajaro (the market cornerer) made out, but prices are already 30% down from this summer's peak and it's hard to imagine that they made a fortune.

The moral of the story is: it is really, really hard to make good risk-adjusted returns by taking directional bets on agricultural commodities. And if nimble hedge funds struggle to do it, we should be very cautious about the expectations we set of any pseudo-public entity (see #5) created to intervene in markets to manage volatility in agricultural commodities.

What 2 degrees would look like

Despite the optimism of climate gurus like Robert Stavins and Trevor Houser with the results of Cancun, a temperature rise of 2 degrees is almost certain and adaptation is here to stay. That's why these two videos by CCAFS (a new CGIAR initiative focused on climate change, agriculture and food security) are interesting. They feel overly scripted and a bit contrived (hasn't the Sahara been shifting back and forth for centuries, even before it had any help from us?), but nevertheless provide some anecdotal illustrations of what agriculture looks like when temperature varies by two degrees. There is a lot of adaptation (e.g. growing trees to shade coffee plants) and also some shift to livestock cultivation as hotter temperatures make land more arid and marginal. Maybe the latter is another sign that we should all just go paleo...

Paleo sustainable at global scale?

As my friends, loved ones and colleagues have probably tired of hearing by now, I've been experimenting since the beginning of October with the paleo diet. In a nutshell, paleo proponents believe that humans evolved over 2+ million years as hunter-gatherers, and only invented agriculture in the last 10,000 years (or is it 30,000? an evolutionary blink, either way), so we haven't had time to adapt, and are healthier eating the "original" human diet.

I won't get into the biochemical pathways responsible or the evidence for or against here (although if you are wondering, I do find paleo very easy to follow and have definitely gotten leaner since starting). The question here is, could 9 billion people sustainably eat paleo in 2050?

The obvious first guess would be no; to get a better back-of-the-envelope, when I have the free time and inclination, I think I'll try to compare productivity of somewhere like Polyface Farms with an industrially produced, grain-based human diet, and post the results here. This of course begs the question of whether Joel Salatin is the right benchmark (it's not realistic to expect the entire world to become enlightened philosopher-farmers, is it?), but it would be a good first step.

In any case, I find the question interesting from both pragmatic and moral perspectives... but until I have a sense of the answer, I am going to stick with paleo myself for all it's worth.

Ethanol quote of the day

Historically our government has helped a product compete in one of three ways: subsidize it, protect it from competition, or require its use. We understand that ethanol may be the only product receiving all three forms of support from the U.S. government at this time.

That's 17 senators from both parties, via the WSJ and Environmental Economics.

New IFPRI modeling and report

IFPRI just published a new report entitled "Food Security, Farming and Climate Change to 2050: scenarios, results, policy options" with new outputs from their robust IMPACT partial equilibrium model. The punch line is:

Our analysis suggests that up to 2050, the challenges from climate change are “manageable,” in the sense that well-designed investments in land and water productivity enhancements might, conceivably, substantially offset the negative effects from climate change. But the challenges of dealing with the effects between 2050 and 2080 are likely to be much greater than those to 2050. Starting the process of slowing emissions growth today is critical to avoiding a calamitous post-2050 future.

The last sentence is a very important one. While attention (including my own) may be drifting toward adaptation, the fact that significant climate change will almost certainly occur is not a binary determination. It could be bad or very bad, depending on the level at which atmospheric greenhouse gases stabilize (or not), and thus in the long run mitigation still has an extremely important role to play. The challenge, of course, is that both the distraction of adaptation and the long time horizon make it very difficult to muster a critical mass of political will behind mitigation actions that impose any sort of economic pain whatsoever.