02/07/2011 02:43 pm ET Updated May 25, 2011

On Destabilizing Food Inflation, Krugman misses the point

Nobel Prize-winning economist Paul Krugman opined today in The New York Times on the reason for high prices in basic foodstuffs, a major inflammatory to the rage we're seeing in the streets of Egypt, Algeria, Jordan, Saudi Arabia and elsewhere.

Krugman is right in how these soaring prices have contributed to Middle East troubles and also correctly warns about the continuing problems that food inflation poses particularly in these Emerging and Third world nations. But the major point of the piece -- the fundamental causes of massive price increases -- unfortunately concentrates on weather events as the cause. On this point, Mr. Krugman is being entirely too easy on the financial forces wreaking their havoc on these very delicate, and until just five years ago, very insular commodity markets.

As I point out in detail in my upcoming book, Oil's Endless Bid, out from John Wiley and Sons in a few weeks, the "financialization" of all commodity markets, but most particularly oil, has not only unnecessarily pumped up the prices that you and I pay for gasoline and corn and wheat, but has made those prices far more viciously volatile. It is that volatility, even more than the outsized price inflation, that has added so much to the instability in the Middle East and elsewhere.

We've seen commodities turned into facsimiles of stocks, something they were never designed to be. And yes, there are undoubtedly fundamental reasons for rising prices in oil, corn, wheat, soybeans, coffee and cotton. There is flooding in Australia, drought in Russia, lighter output in South America and reduced crops from India and China. All of these fundamental and weather related events are real. But the outsized inflation in the cost of these commodities from these events is not. In the last year alone, Wheat is up 80%, Corn up 94%, Coffee has almost doubled and cotton is up a staggering 158%.

I watched in 1991 as oil rallied $10 dollars over the course of two months as we were preparing to enter a full-fledged war with Iraq, a significant oil producer, that threatened to include Kuwait and Saudi Arabia. Last week, I watched oil rally $4 dollars in a day on the reaction to protests in Egypt, a relative non-participant in global oil. Clearly the financial access and speed of that access to investors and traders has permanently changed the way that commodities are priced and the influences that ultimately work on them.

Even the smallest fundamental input can create a multiplied financial effect in commodity markets, using the quick acting commodity indexes, managed futures funds, commodity trade groups, ETF's, ETN's and personal futures accounts available today. Even if you wish to argue that the prices we ultimately see from these financial players working on global commodity markets are "fair" -- a view I very much disagree with, but economist Krugman believes -- it is impossible to argue that they are far less reliable: Monster moves both up and down in basic foods and oils have been happening with far greater frequency and unpredictability.

And this unreliability and volatility is becoming a global issue -- where the US is better equipped to deal with food prices that double over a year's time as less than 10% of wages go towards food -- events in Egypt, where more than 40% of wages are spent on basic foodstuffs, has proven how quickly other nations can be destabilized by these roller coaster price moves.

What can be done? It is clear that the CFTC is moving slowly and may ultimately be unable to put into effect the few governors on massive price swings that Dodd-Frank legislation hoped to help control. But perhaps that analysis is best saved for another blog post.

For today, it is enough to recognize that some facile arguments of food commodity inflation, even those made by Nobel prize winning economists, are worthy of very serious exploration and better understanding.