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Wednesday, August 11, 2010

Wheat Price Rise

This week, Russia announced that it would ban the export of wheat between August 5th and December 31st citing the need to keep domestic wheat prices down. The theory is that, despite the drought and bushfires that have destroyed millions of hectares of crop, by not allowing wheat to leave the country, the supply of wheat in Russia won’t dip and so the price will remain steady.

Some say that the implications on the rest of the world will be grave. Russia’s wheat exports account for 11% of the world’s total. With all that gone, the supply curve should shift inwards resulting in a higher global price. This would lead to a rise in revenues for wheat exporting firms as wheat – being a necessity – has an inelastic demand curve.

Despite these pessimists, others say that because of a bumper wheat crop elsewhere in the world, the supply curve won’t shift inwards and therefore prices will remain steady. However, I feel that this will only happen if governments release some of their stockpiles. This is because private wheat exporters have no incentive to sell their surplus to make up supply. As mentioned, firms benefit revenue-wise from higher prices. Unfortunately, the chances of governments taking any meaningful supply-side steps look bleak. Wheat prices have risen 90% since June – governments haven’t really tried to use their stockpiles to ensure price stability in the last two months, so logic says that they won’t do much to prevent the price rise that will follow Russia’s ban.

With wheat prices rising, there will be cost-push inflation in consumer foods like breads and pizza as food processors pass on their higher-costs. The market is already reacting – shares in firms like Nestle and Carlsberg have tumbled. Substitutes like rice and potatoes may also see a rise in demand though even their prices are rising. Hence, what we may see in the near future is substitutes like rice and potatoes behaving as Giffen goods – in other words, their demand may rise even as prices rise (so the demand curve looks like a supply curve).

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2 Comments:

At September 8, 2010 at 8:28 PM , Anonymous Anonymous said...

Unlike energy, the stocks of crops are cyclical. Expect Australian, Canadian and US Midwest farmers to switch to wheat from corn and soybean and wheat prices to slide down (and yes, corn and bean to go up). Notably, it is easy to switch from corn/bean to wheat but not vice versa as wheat grows easily, does not need much water. But it will be hard for say some in Australia to switch to corn from wheat for want of water.
Ahmad

 
At September 9, 2010 at 4:44 AM , Blogger Deep Vaze said...

Thanks for commenting Ahmad. I didn't know about the relative ease with which farmers can switch from corn/bean to wheat compared with going the other way around.

 

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