Last Tuesday, the Bureau of Labor Statistics released a report indicating that the Consumer Price Index rose by 0.4 percent in May and has increased by 2.1 percent over the past year. This means that if you didn’t receive at least a 2 percent raise this year, your purchasing power has declined compared to last year. But not to worry…
The following day, Federal Reserve Chair Janet Yellen dismissed the CPI report as “noisy.” Perhaps she overlooked the recent announcement from In-N-Out, the legendary California hamburger chain, about their price hike due to the rising costs of dairy and beef. Is this just noise as well?
In Yellen’s perspective—a world where the polar vortex is seemingly responsible for sluggish GDP—it may very well be. Yet, the surge in dairy and beef prices can be attributed to the severe drought in California. According to the chair of the Fed, these price increases are simply noise.
The way the Federal Reserve determines what constitutes noise and what does not remains unclear to us. In our view, rising prices are simply rising prices. As for the California drought, we took a drive through the affected areas on Sunday.
What follows are some observations and reflections, drawing a connection between the parched agricultural lands and the Fed’s low-interest credit.
Economic and Agricultural Stimulus
Descending the grapevine from Tejon Pass along Interstate 5, you encounter a vast stretch of agricultural fields. The farms found in California’s San Joaquin Valley differ significantly from the 160-acre family homesteads of the 19th century; they are now large, highly productive corporate farms.
While these extensive agricultural enterprises are impressive, what’s even more astounding is their very existence. Given the region’s natural challenges, the ability to cultivate anything besides cacti and scrub is quite miraculous.
“The southern section of the valley was a barren desert with scattered saltbush when first encountered by Don Pedro Fages in 1772,” wrote James Parson, Professor Emeritus at the University of California, Berkeley. “In southwestern Kern County, annual rainfall is less than five inches and maybe ten inches at Fresno. In the summertime, pan evaporation can exceed 20 inches.”
Nonetheless, the stark landscape did not hinder progress. With creativity, subsidized water access, and a supply of inexpensive migrant labor, humanity transformed this region into what has been called “the world’s richest agricultural valley,” showcasing a remarkable technological feat in productivity.
However, this reliance on chemical fertilizers, pesticides, and diverted water isn’t without its consequences. What has fueled the agricultural success story of the San Joaquin Valley over the last century is a combination of factors that have similarly propped up the American financial markets and government debt for decades—specifically, cheap credit and excess liquidity.
The Paradox of Fed Credit
In the San Joaquin Valley, vast irrigation systems transport water thousands of miles to cultivate the land. But as surface water moves along California’s aqueducts, it becomes increasingly saline. When applied for irrigation, the leftover salts accumulate in the soil.
Over decades, this soil salinity has reached levels that suffocate plant roots. To counter this, excessive irrigation is necessary, as the irrigation water—though saline—is less salty than the irremediable soil. This surplus watering momentarily refreshes the soil around the plants, allowing crops to grow. Yet, paradoxically, this over-watering escalates the salt concentration in the soil.
In this broader paradox, the water that sustains the farmland is simultaneously the source of its degradation.
The U.S. economy mirrors this situation. Following six years of expanding its balance sheet and injecting cheap credit and liquidity into financial markets, the Federal Reserve has uncovered a similar conundrum.
They must continue to increase the money supply to keep the economy afloat, but this very act may ultimately endanger its survival. It is likely that the Fed won’t change course until compelled to by market forces; by then, they may have lost all control. In the case of the San Joaquin Valley, the drought may only be a temporary concern, yet once the soil becomes too salty, what was once fertile land may become barren forever.
Postscript
Currently, we are in San Francisco, balancing work and family time, enjoying iconic cable car rides along Powell Street and exploring diverse neighborhoods such as Chinatown, North Beach, SoMa, Sunset, Marina, and Fisherman’s Wharf, while indulging in fresh crab and pasta. Before we return to our activities, we’d like to share a few lines from Frank Sinatra…an ode to this distinctive American city…
I left my heart in San Francisco
High on a hill, it calls to me
To be where little cable cars climb halfway to the stars
The morning fog may chill the air, I don’t care
My love waits there in San Francisco
Above the blue and windy sea
When I come home to you, San Francisco
Your golden sun will shine for me
Sincerely,
MN Gordon
for Economic Prism
