With the U.S. on the verge of recession, skyrocketing commodity prices could produce economic conditions similar to those of the 1970s
The figures cited during last month's U.S. Commodity Futures Trading Commission meeting and webcast in Washington were jaw-dropping, even for those viewers who were already familiar with how quickly the costs of agricultural staples have risen during the past year.
“We gather during extraordinary times for our agricultural markets,” said CFTC acting chairman Walt Lukken to a forum of farmers, commodity traders and analysts. “Commodity prices across the board are at levels not experienced in many of our lifetimes. In the last three months, the agricultural staples of wheat, corn, soybeans, rice and oats have hit all-time highs. During the last year, the price of rice has increased by 118%, wheat by 95%, soybeans by 88%, corn by 66%, and cotton and oats by 47%.”
Presenters and participants in the forum agreed that there were several factors impacting the markets now. Emerging economies — primarily those of India and China — are producing a new global middle class that eats more, and can afford to eat high-quality foods like meat and dairy products more often, pressuring worldwide demand.
Meanwhile, prolonged droughts in Australia have battered rice and wheat exports to Southeast Asia. In turn, many affected countries have placed export restrictions on their own crops, worsening the problem. Global energy prices are making agriculture and food supply chains more expensive across the board, and the problems with corn-based ethanol are becoming common knowledge. Growing corn for fuel makes it more expensive as a source of animal feed. With corn so profitable, farmers aren't devoting as much acreage to crops like soybeans, which are themselves an important component of animal feed and many consumer foods. Input costs for beef, pork and poultry producers have ballooned as a result, and the U.S. is still no closer to weaning itself off of foreign oil supplies.
In a presentation at the CFTC meeting, Gerald Bange, chairperson of the World Agriculture Outlook Board for the Office of the Chief Economist of the U.S. Department of Agriculture, noted that U.S. wheat stocks are at a 60-year low, and worldwide wheat stocks are at a 30-year low. Corn stocks are down sharply in 2008 and likely to decline further even after this year's harvest, and worldwide soybean usage currently exceeds worldwide production by 400 million bushels per year.
The numbers are alarming, and as several economists have begun noting, this combination of higher commodity and energy prices coupled with a recession bears a resemblance to the factors that ultimately led to “stagflation” in the mid-1970s.
Bill Bishop, founder and chairman of research consultancy Willard Bishop, Barrington, Ill., said he doesn't believe we've started to enter a period of stagflation, but he agreed that it's a looming possibility.
“From an economic point of view, I don't think we've started to enter the stagflation that characterized that period of time, but that's the threat. That's the fear,” he said.
“And the nature of operating a retail business in an inflationary period is quite different than in a period of stable price inflation. In some instances, it looks like a better deal, because you're going to maintain your margin percents and generate more dollars. There's a point where inflation is beneficial to retail. But then there's another point, where inflation starts moving at a faster pace, it's not as easy to pass [price increases] on, so there's some margin compression, and the traditional metrics that people are used to using for managing their business don't turn out to work as well.”
In the 1970s, the federal government attempted to slow rising food costs with price controls, while the Federal Reserve raised interest rates to double digits, making it painful for businesses to finance capital improvements, equipment or expansion. Supermarkets were caught in the middle, and as the face of food retailing to shoppers, they also bore the brunt of consumer dismay at the spiraling cost of essentials.
In a November 1974 consumer survey by Yankelovich, Skelly & White, 72% of respondents said that supermarkets were not striking a balance between their profits and their “public responsibility.” Among the survey's other findings, 63% of respondents said they believed that supermarkets were still making lots of profits off of shoppers; 58% said they were eating less meat to save money; 30% said they were consuming less dairy; and 16% admitted that they regularly cashed in coupons for products they didn't purchase.
Of course, food retailing has changed significantly during the past 30 years. Bishop said that the range of formats now available to shoppers — including club stores and low-cost formats — would likely help blunt calls for government intervention and price controls if prices continue to rise steeply.
Club stores, in particular, are especially appealing to shoppers looking to save big on bulk purchases.
“The group that is most at risk for supermarkets are the consumers looking to stock up, which represents approximately 36% of today's consumers,” said Scott Marden, director of market research for Vertis Communications, a research and consumer marketing firm in Baltimore. “Currently, 15% of those stocking up list wholesale clubs as their primary channel for perishable items other than a traditional grocery store.”
In a recent research report by Vertis, “Customer Focus 2008: Economic Study,” 91% of respondents said they will be changing their buying behavior in 2008, given current economic conditions. Almost 60% said they planned to begin bundling shopping trips to save on gas.
However, Marden added, consumers in recent years have become more passionate about food, and are still very focused on nutrition. “These factors, combined with strong value positioning, should serve the supermarket community well in today's economy,” he said, adding that supermarkets have done a good job of improving the perception of private-label products in recent years.
“Vertis' Customer Focus research shows that more than 80% of all consumers already have positive things to say about private-label brands, and many (56%) think their quality is just as good as major brands. These positive perceptions should continue in our current environment.”
Bishop noted that the economic situation in the 1970s brought about the birth of generics, and that a similar period of rising costs could present an opportunity for lower-tier private-label products.
“Before price controls, there had been a pretty consistent movement up with costs, and maybe even slightly ahead of costs. So there was a gap that was created that generics ultimately came in and filled. A very practical suggestion would be to recognize that 30 years ago a gap occurred, where a useful — but not necessarily — first-line product was demanded. Anticipate that people will be trading down, and making some trade-offs in quality.”
Retailers should be prepared, regardless, for a period of sustained inflation.
“On the practical side, they should have a plan that will allow them to maintain their pricing strategy while they pass through costs,” Bishop said. “Another thing that is different today [compared with the 1970s] is open communications. In today's world, retailers can engage in discussions, in the broadest sense, with their customers, explaining the situation, explaining what they're doing to ameliorate the impact of it. Anybody who cares is going to get into this dialogue anyway.”
One point of concern is how trading down will affect natural and organic foods, which have become an exciting, profitable category for mainstream food retailers during the past six years.
In a February conference call, John Mackey, chief executive officer of Whole Foods Market, Austin, Texas, said that historically, the chain's sales have been highly resilient during economic downturns. “We attribute our strong sales to many factors, including our loyal customers and their dedication to a natural and organic lifestyle; our high percentage of perishable product sales; and our extensive selection of high-quality prepared foods that attracts customers trading down from restaurants.”
Of course, Whole Foods was a privately held, 12-unit natural foods grocer in 1992, at the end of the United States' most recent prolonged downturn. It's a very different chain now.
Yet research from groups such as the Natural Marketing Institute, Harleysville, Pa., and the Organic Trade Association, Greenfield, Mass., tends to indicate that core organic consumers are a very loyal group that believes consuming products produced without the use of pesticides and artificial ingredients is a long-term investment in their health.
In a newsletter to investors last month, Scott Van Winkle, managing director of equity research for Canaccord Adams, Boston, noted that negative news about the U.S. food supply — including import scares and a large number of product recalls last year — continues to push a growing number of consumers toward natural, organic and local foods, even in the face of an economic downturn.
“Right now, I think [supermarkets] are getting the benefit of shoppers trading down from eating at restaurants, so we haven't seen as much of an impact on food, unless it's premium specialty food,” Van Winkle told SN.
Still, if there is an impact on natural and organic food consumption, he predicted that it would affect conventional supermarkets first.
“I don't think there's going to be a significant impact on natural and organic foods, but if there is an impact, it's probably going to be felt more in the conventional supermarket channel than in the core natural channel,” he said. “The reason is, those crossover consumers are probably not as resilient. The irony there is that the prices are going to be better for natural and organic foods in traditional supermarkets than they are in independent natural food co-ops and natural food retailers. But it's the consumer that's different, in my opinion.”
Van Winkle suggested that at conventional supermarkets, the categories that could face a higher risk of trade-downs include natural and organic personal care products, gourmet organic items, and some perishables categories where there is no brand loyalty, such as organic vegetables. He expects other categories, such as organic dairy, to be resilient in all formats.
Regardless, prices for food will likely continue rising in the near term, presenting significant hardships for many Americans — and more so for people in poorer countries around the world. But several industry leaders are already arguing that prices will subside once non-commercial investors back off of the commodities markets, and as governments in the U.S. and Europe adopt more moderate goals for ethanol and biofuels production.
“Several irrational or exceptional factors are influencing the current market. I'm thinking particularly of droughts, speculative funds which are looking for good returns, and the keen interest in biofuels,” Paul Bulcke, the new CEO of Nestlé, told Swiss newspaper Le Temps in a recent interview. “Sooner or later the funds will realize their profit, and the pressure will decrease. The biofuels debate will become more balanced. Certain structural factors, like demand from emerging countries, will remain, but the situation will normalize. The price of milk is already in the process of decreasing.”