Inflation? Corn Prices Up 44%, Soybean
Prices Up 26% in Two Months!

InflationThe U.S. Midwest is in the midst of the most severe drought in 50 years. The brutal conditions are destroying corn, wheat, and soybean crops, sending the prices of many agricultural commodities rocketing higher—another knife cutting into consumer confidence and consumer spending.

Since June 1, corn prices are up 44% and soybean prices are up 26%. (Source: Wall Street Journal, July 25, 2012). Corn, soybeans and wheat go into many of the products that Americans buy every day and, as those prices rise, consumer confidence falls.

The other side effect of higher corn prices is due to the fact that ranchers use corn to feed their cattle, poultry and livestock. Since the cost of feeding their animals is increasing dramatically, farmers have begun slaughtering their livestock much earlier than usual. This will drive meat prices down temporarily, but, in a few months, less supply of livestock will eventually lead to higher meat prices, which will eventually dent consumer confidence.

Higher grain and meat prices will eventually “feed” into higher food prices at the grocery store and local restaurants in the coming months, which will again hurt consumer confidence and reduce consumer spending on other items.

Although difficult to gauge how much higher food prices will be next year, the Department of Agriculture is estimating that food prices will rise between three and four percent in 2013, at the very least, which will affect consumer confidence at least by that much.

Sure, food costs represent only 14% of the average American’s living expenses, which will result in only a minor hit to consumer confidence. But for lower-income Americans who are struggling in this economy, food costs represent a higher portion of their daily income, with estimates ranging anywhere from 30%-50%.

In an already weak economy teetering on the brink of recession, another headwind will not strengthen consumer confidence and will in turn reduce consumer spending.

The U.S. is not alone in experiencing its worst drought in decades; India is in the midst of one right now, ruining crops and hurting consumer confidence and consumer spending in the rural part of the economy, which represents 50% of India’s entire consumer spending. (Source: Wall Street Journal, August 7, 2012.)

China’s food costs represent around 30% of the average Chinese citizen’s daily living expenses. Higher food costs due to these droughts affect countries around the world, not only the U.S.; and China’s citizens will feel this impact, which will result in weaker consumer confidence and so a slowdown in consumer spending.

The reason I bring up India and China, dear reader, is that, while many believe that higher food costs will not have a major impact here in the U.S., they forget the indirect impact to the U.S. economy, which will in turn negatively affect consumer confidence and consumer spending.

With the recession in Europe and the slowdown in the U.S., many are hoping that China and even India will continue to reduce interest rates and create spending programs to stimulate their economies and thus consumer confidence, which will help both Europe and the U.S.

The problem is that, with food prices representing a larger part of India’s and China’s income, inflation will soon become a problem, because higher food prices will “feed” into India and China’s Consumer Price Index (CPI), not to mention the negative effect it will have on consumer confidence and consumer spending.

How can China and India cut interest rates and print money if inflation becomes a problem?

Besides the fact that higher food prices come at a time when consumer confidence in the U.S. is fragile, the boost the U.S. and the European economies were looking for from India, but especially China, may not materialize due to the food inflation that will rear its ugly head very, very soon.

I’ve written about how fragile the U.S. consumer has become. Just last week, I wrote about how consumer credit card spending is contracting fast (see: “Consumer Credit Card Spending Contracts Most Since April 2011”). Consumers are closing their wallets and saving, instead of spending (see: “Personal Savings Rate Hits One-year High: Why Consumers Are Too Scared to Spend”). Sharply rising food prices will put more pressure on consumers to pull back on discretionary spending. The gross domestic product (GDP) numbers for the third and fourth quarter of 2012 may look worse than economists currently forecast.

Michael’s Personal Notes:

Italy’s economic contraction deepened, as its GDP fell 0.7% in the second quarter of this year. What is more disconcerting is that, year-over-year, in the first quarter of 2012, GDP contracted 1.4%; while, in the second quarter, the economic contraction worsened, as GDP shrunk by 2.5%.

Italy’s Retail Confederation predicted last week that consumer spending would fall by the most in 2012 since WWII!

In Spain, the economic contraction continues unabated as well. What this means, dear reader, is that these countries will require help from the stronger nations of the European Union.

The problem is that the AAA countries of the European Union—Germany, Austria, and the Netherlands—are starting to show evidence of economic contraction within their countries and could follow their weaker counterparts into recession!

Austria’s manufacturing contracted in July and the country’s new orders—a gauge of future demand—fell at the fastest pace in eight months. (Source: Markit Economics.) Manufacturers cut jobs for the second straight month in Austria and the economic contraction is worsening, as the number of jobs being lost has accelerated to levels not seen since 2010!

The Netherlands experienced a continued decline in manufacturing, with new orders falling for five straight months. The economic contraction continued to worsen, as job cuts took place for the fourth consecutive month.

Finally, there is Germany. With 60% of its exports making their way to the European Union, the most important AAA country of the European Union is showing signs of renewed economic contraction, which has German leaders talking about a possible recession in the second half of this year. (Source: Reuters, Aug. 10, 2012.)

It is not only the persistent declines in manufacturing, imports and exports; the largest companies within Germany are set to lay off thousands of workers, as the economic contraction throughout the European Union leaves them with little choice.

When Greece first imploded, the stronger European Union countries helped Greece, but their economies were not experiencing the economic contraction they are now. Greece is a small economy, but Spain and Italy are some of the largest economies within the European Union.

Now that Spain and Italy need help, how likely are the people of Austria, the Netherlands and Germany to help them when they are going through their own economic contractions that could very well lead to a recession? Furthermore, these countries may blame Greece, Spain and Italy for overspending and causing the crisis in the first place, which has led to the severe economic contraction their countries are now facing.

Be very careful. The crisis in the European Union is far from over and could possibly lead to a breakup. The implications of the decisions made will have far-reaching effects, including on the U.S. stock market.

Where the Market Stands; Where It’s Headed:

We are in a bear market rally in stocks that started in March of 2009. Technically, a firm head-and-shoulders pattern has been completed by the Dow Jones Industrial Average. But the Fed tells us it has more ammunition up its sleeve. We are patiently waiting for the market to deteriorate, at which time we believe a form of QE3 will be released to support the market. After that, all bets are off.

What He Said:

“As investors, we need to take a serious look at our investment portfolios and ask, ‘How will my investments be affected by an American-grown recession?’ You should take what precautionary steps you can right now to protect yourself from a recession in 2007. Maybe you need to cut your own spending or maybe you need to sell some stocks that will take a beating during a recession. You know what tidying up you need to do. Don’t procrastinate…get to it now. And please remember: recessions can happen quickly, stock markets don’t go up during recessions, and the longer the boom before the recession, the longer the recession. Just based on my last point, we have plenty to worry about in 2007.” Michael Lombardi in Profit Confidential, November 13, 2006. Michael was one of the first to predict a U.S. recession, long before Wall Street analysts and economists even thought it a possibility.