Fed Expert: How to Fix the Food Crisis Now

Food prices are soaring worldwide. Yet policymakers are not effectively fighting the increases.

In fact, they are probably just making things worse.

So argues Vincent Reinhart, former director of the Fed's Division of Monetary Affairs, writing in The Wall Street Journal.

Reinhart, now a resident scholar at the American Enterprise Institute, cites four forces driving up food prices in developing countries such as China, India, Vietnam, Egypt and Indonesia.

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These economic forces were last at work in the 1970s, according to Reinhart, when food prices also rose quickly and over a long period.

Here's what's fueling the increases, in Reinhart's opinion, and here's what he suggests to counteract them.

First, monetary policy is in overdrive.

The current real interest rate of 2.25 percent — the nominal rate minus inflation — is less than the consumer inflation rate.

A "negative” interest rate stimulates business investment and makes global investors less inclined to support the dollar in monetary markets.

This occurred last in the mid-1970s, boosting demand and driving up food prices.

Simultaneously, the dollar fell against foreign currencies, and economic growth was stifled. The result was the dreaded stagflation effect — rising prices in a slowing economy.

Exchange rates in disarray is another inflationary factor, Reinhart says.

A disparity in the movement of various global exchange rates — some too little, some too much — aggravates the problem.

For instance, rates are not moving enough in oil producing and emerging markets such as China, India, Korea and Saudi Arabia, which set rates roughly in accord with the U.S. Federal Reserve.

The result in these booming economies is inflation. The remedy, of course, is a readjustment of rates to reflect specific economic conditions, country by country.

In nations whose currencies float freely, such as in Europe and in Canada, the dollar declines against them, and the price of food — and anything else denominated in U.S. dollars, like oil and minerals — goes up.

Policymakers, maintains Reinhart, have capped exchange rate movements, adding to inflationary conditions in their own economies.

Thirdly, clumsy government intervention also fuels food inflation, says Reinhart.

Not to belabor the obvious, but U.S. government encouragement of ethanol production — an inefficient and too-costly enterprise, contend analysts — has boosted corn prices to double that of three years ago.

Consequently, the price of corn-fed livestock goes up, the price of substitute grains goes up, and other by-products of corn and grains also rise. As guru investor Jim Rogers notes, even clothing gets more expensive, as cotton farmers plant grain instead and textile mills run short of cotton.

The remedy is simple enough, Reinhart says. Cut subsidies to corn producers. This would ripple throughout the global economy as a model for other nations to copy.

Finally, Reinhart writes, runaway oil prices are a major inflationary factor.

In the 1970s, OPEC cut back on production, driving up prices for crude and gas. Today, expanded demand keeps prices rising, with the cost of crude now four times what it cost in 2001.

The Asian labor force spends the bulk of their income on food, and agriculture is a heavy user of petroleum fuels. That makes common foods there — rice, grains, pork and poultry — more costly.

Reinhart proposes no specific solution to the oil problem. That one will have to wait until widespread use of alternate energy sources become a reality — or the world’s economies contract dramatically, cutting demand.

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