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One of the most vexing problems faced by modern economies around the world is how to bring inflationary forces back into control without driving their economic activity into negative territory (i.e., recession). The choices they make will have big impacts throughout the agricultural sectors globally including for pork producers. Everyone knows that when the price of pork rises, people eat less of it and that reduces the amount demanded both internationally and domestically. Here we are talking about less “quantity demanded” because prices have risen. Everybody gets that. However, that’s only the beginning. As inflation drives up the cost of nearly everything including pork, real incomes fall and if that is sustained, demand (the long-term desire for a product at various prices) falls. These are two different effects.
If you are scratching your head at that distinction, consider this: When the price of pork rises, people will buy less and transfer purchasing to a less expensive substitute protein, like chicken. When real incomes fall, people will buy less pork at every price, meaning that if prices come back down to previous levels, less pork will be purchased than before at every price, high or low. This is called demand destruction and it is a very real prospect, and the consequential destructiveness of prolonged inflation.
By the exact same principles, but on the production side, global pork production has slowed (the “quantity supplied” to the market) due to the high cost of feed and energy along with almost every other thing a pork producer buys. When farm profits (real income) falls, the double whammy mentioned above happens and supply contracts (some go out of business or reduce sow herd size, etc.) so that producers are unwilling to provide the same amount of pork that they once were are previous prices. In the EU regionally, due to disease issues like ASF and continued government policy pressures, which make expansion difficult in the traditional EU powerhouse producers like Germany, Denmark, France and the Netherlands, Spain has emerged over time as the only real growth area. There has been supply destruction which will never return to those places at least at previous levels.
In the US, there remains an entrenched problem of finding enough workers to fill job vacancies which occurred during the two years of pandemic. Up go wages to attract more labor. Now feed, energy, and labor, the three greatest costs of production are rising without a real prospect for decline on the horizon. Many of the largest pork producers are reporting they are only able to get the basics accomplished with little time for needed maintenance, training, vacations, and systematic improvement of production due to labor shortages. This is not all going to go neatly back to the way you remembered it pre-pandemic maybe in your lifetime.
We know that inflation was first setup and unleashed when governments caused incomes to continue under the COVID-19 lockdown period while production of food and other goods were substantially reduced. Government strategies to combat COVID-19 often played havoc with supply chain efficiency like lockdowns of ports, mandatory vaccination and quarantines. People reacted with what has been called “the great resignation”, namely, people simply quitting their jobs and taking new ones with more benefits or deciding to stay at home for many, many months and taking extended government payments. Many of these government payment schemes were outright transfers of wealth exceeding the income the employee could make if he/she returned to their regular job and they continued for months and months on end. The classic definition of inflation is too many dollars/euros etc. chasing too few goods. Ports were closed, truck drivers were forced out of their cabs or blocked from delivery without proof of vaccination, plant workers became ill and were quarantined and many people simply quit their jobs, but nominal incomes continued or even increased. That is about to change.
Now we add the war in Ukraine which is further disrupting supply chains for food and energy primarily, and in turn dramatically raising the cost of food production and reducing the availability of small grains and natural gas to importing nations throughout the region and beyond. If I live in Germany and I must pay double or triple to heat my house this winter along with all the other increased costs, my real income has fallen, and I will be buying less of everything (more or less).
The cures being attempted now are increasingly raising the risk of demand destruction, permanent reductions in demand due to consumers beliefs that income will be permanently reduced going forward. Add to that the dangerous idea that these high energy prices are an efficient way to transition out of fossil fuels (so they are a good thing) and you have the specter of stagflation, namely, inflationary prices that are not cured by rising unemployment. Economic stagnation in the presence of rising prices.
Some evidence of this is beginning to appear as the US and EU consumer outlook has plunged, leading to less purchasing of discretionary goods while demand is shifting away from purchases that are easily postponed like clothing, furniture, new carpet, some maintenance services, new construction, and meals at restaurants. Consumers in both the EU and the US are beginning behaviors like “trading down” to cheaper or generic brands of food, alcohol, cigarettes, and other household goods as well as slowing savings and increasing credit card purchases on disposables.
The big fear is that governments will go too far in slowing purchases. As this happens, inventories begin to build, company profits are reduced which leads to laying people off and then the permanent closing of some production facilities. The building of inventories was accelerated this time around because many companies predicted shortages due to supply chain disturbances and began hoarding goods to sell in the current period six to twelve months ago, the same way you probably hoarded toilet paper or surgical masks at the beginning of the pandemic when store shelves for basic household items began to go bare. Now they are getting ready to dump these inventories as they lay people off.
Lastly, and more on this next time, China seems to be inching closer to ending its tremendous generational growth rates. Its housing market is in turmoil and its methods of containing pandemic outbreaks severely curtail economic activity which then ripples around the world. Should China fall into a deep and sustained recession, it will pull the rest of the world down with it and largely render the monetary policy tools of the United States and the EU (like raising and lowering interest rates) much less effective. Pork producers in developed countries have gotten used to gradually increasing world demand but that could be easily upended for an extended period setting off a brutal level of global competition among producers for a shrinking global demand that will strongly resist kickstarting into a resumption of growth.
