Price controls or government "subsidies" skew markets and should only ever be used as a short-term tool.
Why? Because they keep prices artificially low... as a result we, the consumers, feel artificially better off.
Right now there are two subsidies distorting the global market. They’ll ramp inflation... skyrocket food prices higher than they’ve ever been... and create a time-bomb for petrol prices the world over.
The hidden risk premium ethanol mythmakers don't want you to hear about
The two price controls distorting the global market right now are US ethanol subsidies and petrol subsides in countries like the US, China, India, Iran. Many other countries do the same.
First let’s look at ethanol.
Ethanol subsidies have caused the food price to soar... and they will keep oil high for the foreseeable future.
See, you make ethanol from food. And it’s expensive to do. So the US administration, in an effort to ween the country off their addiction, encourages farmers to plant food crops for ethanol production by taking away a lot of the cost.
This way, farmers can grow food crops cheaply and make more money selling it to ethanol producers in the market.
The result? Farmers switched crops to lucrative bio-fuels. And who could blame them? They are businessmen who will plant whatever makes them money.
It is all down to subsidy - but it means there is less crops available for food, supply is down, prices go up.
Now let’s look at oil...
It’s not only Middle Eastern countries that provide their people with subsidised petrol. This happens in India and China as well.
Last year, India spent $19bn on fuel subsidies. China has also recently entrenched its subsidy programme - which some analysts reckon could cost the country as much as $87bn this year.
All of this means that the average Chinese or Indian person can buy petrol cheaper than the "market" rate. This keeps people happy and stimulates the economy. The governments can then cut back on these subsidies sometime in the future as the economy grows... or that’s the idea anyway.
Trouble is: food-price rises have thrown a spanner in the works.
When petrol is heavily subsidised, consumption ALWAYS rises.
If petrol is cheap, cars are used more and there is no motivation to drive a more fuel-efficient vehicle.
Both governments have been trying to cut these fuel subsidies. They are a tax burden that their economies simply don’t need. However, the emergence of food-price inflation (caused by subsidies in the US bio-fuels industry) has left their hands tied.
Food-price inflation has taken over from energy as the world's biggest price threat. It would be politically untenable for these two countries to start cutting fuel subsidies as ordinary people are being ravaged by inflation in basic necessities. It would lead to unrest... by that I mean rioting.
India does not want civil unrest ahead of its election next year and the Chinese are trying to boost their PR ahead of the Olympic Games. A cut in fuel price subsidies would be very damaging politically. Quite simply, it is not going to happen.
Of course, the government could transfer the petrol subsidies directly to food. But this would cause an economically catastrophic rise in energy costs for individuals and businesses. It would also raise food demand and stoke inflation in grains and staples even more. There is quite simply nothing they can do.
So, subsidies elsewhere have a damaging inflationary effect - and the US’s attempt to reduce its reliance on oil has caused significant economic damage.
Here’s what’s really going on in the food-oil link:
- The oil price rose, so the US subsidised ethanol production to reduce reliance on imported oil.
- US farmers switched to more lucrative crops and burned food for fuel.
- With less crops available for food, staples prices rose.
- In order to reduce oil prices, demand needs to be dampened - or supply increased.
- Supplies of oil are finite and new finds are few and far between - making the supply side tight.
- Oil demand in India and China has been inflated because of internal petrol subsidies.
- The soaring cost of food means cutting petrol subsidies is politically untenable.
- Petrol remains cheap and demand increases, keeping the oil price high.
This is a vicious circle. The root cause of it is US subsidy for ethanol.
And it will push food and oil prices higher and higher for years to come.
Regards,
Garry White
Editor
Smart Commodities UK
P.S. Garry White is the editor of Smart Commodities UK. He explores the overlooked and very profitable world of natural resources and hard assets. Garry researches those companies that are sitting tall in producing basic goods, such as raw materials and energy - the things we want, and need, in everyday life. He delves into what's going on in the sector, the hot opportunities for you to profit from, and the exact stocks you should buy as this unprecedented commodities boom fires on. Start your no obligation 3 month trial!
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