By Greg Peel

In early 2008, world grain prices spiked as a variety of weather issues combined across the globe, from drought in Australia to floods and droughts elsewhere across the world's major grain growing areas. A spike in grain prices flows through to a spike in meat prices, given the proportion of crop harvests consumed as animal feed. To make matters worse, the 2008 price spike coincided with the Bush Administration's ill-conceived ethanol subsidy, which had US farmers converting large acreages of grain-for-food production over to grain-for-ethanol, which only exacerbated the food price surge.

This price surge translated into a spike in global consumer inflation. Food inflation did not impact greatly on the developed world given the corporate and household deleveraging already underway due to the Credit Crisis, which shifted from deluge to torrent after Lehman collapsed. Deflation won out over inflation. In the emerging world however, where food forms a much higher proportion of household budgets, no such deflationary force was in place. Emerging market consumer inflation subsequently skyrocketed.

Beijing was forced to implement massive fiscal stimulus in late 2008 as its developed world export markets collapsed. The stimulus first helped save the world but subsequently sparked a property market bubble in China, requiring Beijing to flip policy over to tightening rather than easing. However, this was not possible at a time when food inflation in China was running in the double digits, and overall headline inflation not much below double digits. Consumer inflation only peaked out in China late last year and this year has fallen back to the comfortable level of 3%, allowing Beijing to ease policy and potentially save the world once more.

There is currently a drought in the US, nevertheless. Corn prices have risen nearly 50% since the beginning of June, with other grains and soft commodity products following closely behind. It's good news in the short term for Australian wheat farmers, who have for once enjoyed solid rains and are looking at another bumper harvest. But if global food inflation takes hold once more, and is again exacerbated in China, Beijing's easing capacity may again be compromised. And that would not be good news for Australia.