Richard Dunbar: Food for thought as Middle East woes drive up risk

IN BRITAIN, we may all be feeling a bit of a squeeze on our trips to the supermarket these days, but in other parts of the world the situation has become rather more grave.

If evidence were needed of the consequences of a hungry world, the likes of Tunisia, Egypt and Libya have brought it vividly on to our television screens.

Certainly, there is more to the political instability in these countries than the rising price of food, but it has been an important catalyst (it was a grocer's self-immolation that set things off in Tunisia). And it has triggered reactions that policymakers in the West are struggling to deal with.

Food is already leading to a redrafting of the politics of the Middle East. Its price, as well as that of oil and other commodities, is exporting inflation around the world. Many argue that this is uncontrollable and that responding with interest rate rises is inappropriate. But more thoughtful central bankers are already making it clear that, as the developed world took the credit for importing deflation, it must be willing to take the pain of this more unwelcome import.

The availability of food is, of course, a problem that the world has wrestled with for hundreds of years. In the 18th century, the British scholar (and incorrigible pessimist) Thomas Malthus warned us that population growth would result in starvation for many.

"The food … which before supported seven millions must now be divided among seven millions and a half or eight millions," he wrote in 1798. "The poor consequently must live much worse, and many of them be reduced to severe distress." History has proven Malthus wrong - in the developed world at least - as human ingenuity and Adam Smith's "invisible hand of the market" showed that a growing population could be provided for.

A high wheat price led to farmers buying land and planting more of that crop, or planting it in place of other, lower-value crops. The increased supply at harvest time helped the price of wheat to fall. If it fell too much, farmers were forced out of business - or towards different crops. The resulting fall in supply would tend to raise prices again.

The principles Smith expounded three centuries ago have been responsible for a number of quantum leaps in production, including crop rotation, new technology and genetic modification. Yields have risen, farmers have prospered and the world, for the most part, has been fed.

I am an advocate of the free market and its ability to allocate scarce resources; it's worked more effectively than any of the alternatives that have been tried. But I wonder how well it is working at the moment - or specifically, how quickly. Undoubtedly, over time, the enthusiasm for commodity investing will trigger greater amounts of capital and prices will fall.But the hungry may not be able to wait that long - and the world that benefits from lower prices may be very different from the one that suffers as they rise.

When food prices do fall, Tunisia, Egypt and Libya will have changed, though it's too early to say whether for the better. But, given the significance of the Suez Canal and the area in general to world trade, events in the Middle East are important to all our wellbeing.

In the unlikely event that the world's hungry were watching the G20 leaders in Paris last month, they would have bemoaned the lack of initiative on food prices. They might also have compared the political inaction unfavourably to the more robust efforts prompted by the global financial collapse. And yet, the geopolitical and economic consequences of food price inflation may be just as far-reaching.

When we look back on this period of economic history, I predict that Thomas Malthus will have continued to be proved wrong and Adam Smith right. As investors in hard and soft commodities, we can - for the time being - enjoy the rise in prices in these new asset classes.

As equity investors, we need to make sure that companies' high raw material prices are reflected in our profit forecasts. As bond investors, we shouldn't forget that the increases in inflation brought on in part by these higher prices will continue to eat into our returns. And as investors in general, we need to be aware that economic, political and regulatory risk is rising - perhaps faster than we think.

• Richard Dunbar is investment director at Scottish Widows Investment Partnership