The worst drought to hit the USA in over half a century has sent international food prices climbing again. Prices for corn and soybeans (the USA is the world’s biggest producer of both) last week passed the peaks they reached during the 2007/8 global food crisis which saw riots in over 30 countries, the number of hungry pass 1 billion, and the humanitarian system overwhelmed by spiralling demand for food aid.

Things are not yet this bad. First, corn and soybeans are not the most important commodities for poor households, which typically depend more on rice and wheat (for bread). For this reason, the impacts of the current spike on hunger and poverty are likely to be limited. Instead, richer consumers will feel the pinch first: corn and soybeans are typically used in animal feed – so the price rise will be felt most by people who can afford to eat meat and are able to adjust their consumption without going hungry. It follows that riots are less likely: it was the price of wheat in 2011 that provided a crucial spark for the initial protests in North Africa that eventually became the Arab spring.

And because riots are less likely, governments are less inclined to impose export controls, reducing the chance of a collapse in confidence, as one country after another bans exports, pushing up international prices further and encouraging others to do the same. This dynamic was a major factor in both the 2007/8 crisis and the 2010/11 spike.

Cause for Concern

However there is still a chance that the spike in corn and soybeans will spread to other commodities, setting us on course for crisis. There are signs of contagion: wheat prices have increased over 50 percent in the previous five weeks, probably as the livestock industry switches from corn to wheat as a cheaper alternative for animal feed. A flurry of export controls among nervous governments or a poor wheat harvest in a key exporting region such as the Black Sea or Australia could easily precipitate a full-blown crisis. The most vulnerable countries to spiking wheat prices remain those of North Africa and the Middle East, as well as Pakistan.

Even if the spike remains largely confined to corn and soybeans, this will still have consequences for a number of countries, most notably Mexico and China. In Mexico, white corn is the national staple and a major component of poor household expenditures. High prices for conventional corn could transmit to white corn if the Mexican livestock sector switches from the former to the latter.

China is the world’s largest importer of soybeans, used for pork, of which it is the biggest consumer in the world. Higher soybean prices will therefore contribute to inflationary pressures within the country. This may lead to a tightening of monetary policy within China, precisely when many would prefer to see it loosened. Alternatively, the government may decide to make releases from its strategic soybean reserve, which trade data indicate has been building since the 2007/8 price crisis, presumably for an eventuality such as this.

Drought Spurs Debate on Ethanol

In the USA, the drought has refocused attention on ethanol, which currently consumes some 40 percent of US corn production. Ethanol’s demand for corn does not adjust to supply shocks such as this. It is set by government mandate so is perfectly inelastic, forcing adjustment instead on the livestock sector and food consumers, amplifying price spikes in the process. Calls have therefore mounted for the mandate to be relaxed so that ethanol bears its fair share of the adjustment burden. The benefits of doing so could be significant. Recent modelling by the UK government found that halving the US mandate during a price run-up could reduce the magnitude of the spike by about 40 per cent.

For now the US administration has rejected this option. It is an election year, and the ethanol mandate is too valuable a subsidy to the politically crucial corn-growing states to be threatened. But the question is likely to return soon, as further price spikes are inevitable: global food stocks remain close to crisis thresholds and are struggling to recover as demand continues to outstrip production growth, markets remain tightly balanced, and no agreements exist to prevent or limit export bans. In these circumstances the world is only one or two bad harvests away from another global crisis, and biofuel mandates appear increasingly hard to justify.