This will be the last post of this blog. Most of its concepts have already been expressed in previous posts, but I want that if someone by chance stumbles upon this blog, the first thing they see is the most important message I want to convey in it.
I started this blog in Oct 2007 with an analysis of the international monetary system, concluding that the US current account would eventually be balanced by a drop in US imports out of either a US recession or a plunge in the dollar's value, depending on the Fed's monetary policy, and that in my view the first path would be the best. By now it is clear that they are headed down the second (with a twist as explained in the last two paragraphs).
Then in Nov 2007 I analyzed the prospects for the oil market in 2008, concluding that, save for a significant US-led OECD recession, the oil price would be significantly higher by the end of 2008. Even though oil (actually total liquids) production has risen more than I expected back then, by now it is clear which way the oil price is heading and how fast.
Then in Dec 2007 I commented on the huge extent to which current economic thinking (not only of theorists, but of people like Bernanke who make decisions which significantly affect the course of events) was disconnected from physical reality. Specifically on the economists' failure to perceive that now it is the physical limits to growth which are becoming the main constraint to economic output, and that in this new scenario it is most unwise to keep stimulating demand. By now it is clear that the disconnect is still as complete as it ever was.
Finally in Jan 2008 I commented on the threat that biofuels posed to world food production: as biofuels are a direct replacement for petroleum products, their prices are directly proportional to those of the petroleum products replaced, plus or less differential taxes/subsidies. Therefore, a higher crude oil price increases the profitability of biofuel production while at the same time decreasing the profitability of food production. As a result, arbitraging based on profits per acre/hectare drives the allocation of agricultural production out of food and into biofuels. As more agricultural production is diverted into biofuels, biofuel production increases and fuel prices consequently tend to stabilize, while food production decreases and food prices consequently rise, until the profitability of food production becomes once again competitive with that of biofuel production and a new equilibrium state is reached where no further diversion occurs. But the key point is that the food production level at this new equilibrium state is LOWER than that at the original state.
As anyone aware of Hubbert's Peak understands, in the absence of a worldwide voluntary reduction of crude oil demand in line with the future peaking and subsequent decline of crude oil production, the prospects for the oil price are of a relentless rise. That, through the profit-based arbitraging mechanism described above, will drive the world into successive new equilibrium states with higher biofuel production and lower food production. Obviously the process will eventually stop before 100% of the food gets turned into fuel. But along the way a large number of poor people wanting to eat will have been outbid by the rich and middle class wanting to fill their tanks.
On the demand side, it is clear that the current path is the exact opposite of what would be required to prevent a relentless rise of the oil price, as the populations of giant emerging economies, particularly China and India, increasingly adopt the oil consumption patterns of the citizens of OECD nations. For which they obviously cannot be reproached: how could Americans ask the Chinese to keep riding bikes as they keep driving their SUVs? That generalized desire to adopt or keep the happy motoring way of life, together with the determination shown by OECD Central Bankers to avoid or minimize a recession (China will probably not have a recession regardless of what happens in the US), just guarantee the outcome that is clearly seen by now: oil demand will not abate and oil prices will keep their march up, dragging food prices along with them.
In this context, any government-induced price distortion (through differential taxes/subsidies) that increases the profitability of biofuel production over that of food production directly amounts to hastening the appearance and aggravating the degree of the coming food crunch. And here is where the issue in the first post (Oct 2007) comes into play: turning an ever greater share of US corn to ethanol (and then soybeans to biodiesel) will cause in a few years the halving of US agricultural exports in volume and their doubling in dollars (i.e. quadrupling agricultural prices). That will substantially reduce the US current account deficit and give the US a significant strategic advantage.
The US has certainly the right to follow that path. But they also have the duty to tell the world openly that they will do it. Like: "Along the coming years and decades our food exports will become progressively lower in volume, and the same will probably happen to total world food production. It is conceivable that they could be half their current volume in 10 years. People, and particularly poor people, should have it in mind when making procreation decisions."