If you had tuned your television to virtually any news program during the month of July, taking care to pay attention to the program for at least a few tortuous moments, you were sure to have had your sense of food security assaulted by images of fields of withered corn stalks flashing across the screen as a fearfully foreboding newscaster intoned in the voice-over how the heat wave and drought in the American Midwest was sure to cause higher food prices for everyday consumers at the local grocery–and maybe even–gasp!–food shortages.   

But is any of it correct?  Or, were newscasters simply doing what they do best in their perfectly coiffed hair and stylish suits: peddling their favorite brand of snake oil—fear—with that characteristic gleam in their eye and sparkle to their smile?

It might help, instead of wallowing in credulity and fear over how the vicissitudes of nature affect the way food is supplied and priced, for the average food consumer to know and understand a bit about agriculture markets, and how supply and demand is mediated by the price mechanism.  

The first thing to know about agricultural markets is that the vast bulk of what comprises food—corn, soybeans, rice, wheat, dairy, meat, sugar, etc.—is traded in international markets.  These markets make virtually no distinction (save transportation costs) over whether, for example, a bushel of wheat is grown in the US or in Russia.   The supply side of the market is therefore marvelously diversified.  A hot, dry summer in the American Midwest might mean supplies are tighter than normal internationally for crops that suffer from hot, dry weather (in this case, corn and soybeans) as the American Midwest is an internationally important agricultural supplier of such crops, but it is hardly the only place where they are grown.  And even in the small portion of the Northern Hemisphere that is the American Midwest, some areas will always fare better, weather wise, than others.  Worldwide, a bad growing season in one area is more often than not offset by bumper crops elsewhere. 

Much has been ballyhooed about the shriveled American corn crop, probably because shriveled corn stalks make such a powerful visual image on a television screen.  But what has the United States Department of Agriculture said about the prospective harvest this year, of corn and other cash crops?  From their Crop Report:

Released August 10, 2012, by the National Agricultural Statistics Service

(NASS), Agricultural Statistics Board, United States Department of

Agriculture (USDA).

Corn Production Down 13 Percent from 2011; Soybean Production Down 12 Percent from 2011; Cotton Production Up 13 Percent from 2011; Winter Wheat Production Up 1 Percent from July Forecast

 Corn production is forecast at 10.8 billion bushels, down 13 percent from 2011 and the lowest production since 2006. Based on conditions as of August 1, yields are expected to average 123.4 bushels per acre, down 23.8 bushels from 2011. If realized, this will be the lowest average yield since 1995. Area harvested for grain is forecast at 87.4 million acres, down 2 percent from the June forecast but up 4 percent from 2011.

 Soybean production is forecast at 2.69 billion bushels, down 12 percent from last year. Based on August 1 conditions, yields are expected to average 36.1 bushels per acre, down 5.4 bushels from last year. If realized, the average yield will be the lowest since 2003. Area for harvest is forecast at 74.6 million acres, down 1 percent from June but up 1 percent from 2011.

 All cotton production is forecast at 17.7 million 480-pound bales, up 13 percent from last year. Yield is expected to average 784 pounds per harvested acre, down 6 pounds from last year. Upland cotton production is forecast at 17.0 million 480-pound bales, up 15 percent from 2011. Pima cotton production, forecast at 663,000 bales, is down 22 percent from last year. Producers expect to harvest 10.8 million acres of all cotton, up 14 percent from 2011. This harvested total includes 10.6 million acres of Upland cotton and 233,400 acres of Pima cotton.

 All wheat production, at 2.27 billion bushels, is up 2 percent from the July forecast and up 13 percent from 2011. Based on August 1 conditions, the United States yield is forecast at 46.5 bushels per acre, up 0.9 bushel from last month and up 2.8 bushels from last year.

If the drought were as severe as claimed, how could wheat and cotton production be doing so well, actually increasing in volume from 2011, and for wheat, increasing on a per acreage yield basis as well, with cotton down only slightly?

A thirteen percent decline in corn production from this year to last (and a similar decline in soybeans), with yields as low as they were in 1995, seems to make prescient the fear-peddling newscasters’ prognostications.   But how does only a thirteen percent drop in output square with fields of shriveled corn stalks as depicted in media stories on the drought?  How could those fields possibly produce eighty-seven percent of last year’s yield?  The answer, of course, lies in the diverse weather experienced by the various locales in which corn is planted, and in the intentional subterfuge of the fear-peddling media.  Not all fields of corn, nor even most of them, not even in the American Midwest where vast seas of corn lap gently in the July breeze in an average year, shriveled up and died like the corn in the fields depicted on the newscasts. 

A thirteen percent decline in corn production in the United States might, but only just might, force a durable increase (i.e., lasting longer than six months) in corn prices worldwide (which would, in turn, filter back into domestic prices), depending on whether other corn producing areas have similarly poor results or enjoy bumper crops, among a variety of other factors.  Market traders in corn, speculating on the US harvest and on problems in other major producers (notably, Russia) have pushed corn futures up about 23% since July.  Only time will tell whether they have speculated correctly, or have, like so many times before, overshot the mark.  Corn, like other agricultural products, has a mysterious way of showing up in the market when speculators have driven its price well above historical norms, and again like most other agricultural products, corn has ample substitution options.  Nobody has to eat cornbread or corn on the cob or corn flakes; even carbonated sodas needn’t be sweetened with high fructose corn syrup.  If corn gets too expensive, more corn will mysteriously appear, while at the same time, demand for corn will mysteriously disappear.  One day maybe, people will realize that images of shriveled stalks is just so much melodrama for selling commercials between broadcast minutes.

On average, over the last half-decade of the aught’s (2005-2010), the United States provided about 40% of the total volume of corn produced worldwide.  It supplied during the same period over half of corn traded internationally, exporting between fifteen and twenty percent of its output each year (all according to the 2012 Statistical Abstract as cited by the US Census Bureau).  The US is similarly important to the soybean markets, producing around forty percent of all the soybeans grown worldwide, and providing about forty-two percent of the total tonnage traded in international markets.

The US is undeniably the most important producer of grains, particularly corn and soybeans, for international agricultural commodities markets (its wheat and cotton production are less important internationally, comprising only about twenty-five and ten percent, respectively, of the amount traded internationally).  But still, as important as it is, the US, with its production fragmented among hundreds of domestic producers, can’t set prices.  No single producer in the US has the market heft to move prices internationally, and at least for now, the US government hasn’t attempted to do it for them, at least not internationally (the recurring farm support bills often ensure farmers receive some minimum price for their crop domestically).

International agricultural commodities markets are one of the closest examples of classical economics’ ideal of perfectly competitive markets anywhere to be found:  Buyers and sellers have access to virtually the same information (imperfect and highly speculative though it may be); no buyer and no seller can independently determine the price of any particular commodity, i.e., all are price-takers; barriers to trade are generally nil (excepting for some favored commodities in individual countries, like rice in Japan or sugar in the US), and supply is reasonably elastic, fungible, and subject to relatively easy substitution, while demand predictably grows along with the population.   

But internationally traded commodities markets, of which agricultural commodities are a major subset,  have a monkey wrench in the works preventing them from ever actually achieving perfectly competitive pricing outcomes.  International commodities are priced in dollars, and are therefore beholden to the value of the dollar relative to its trading partners.  If the dollar itself is strong internationally, prices for internationally traded commodities will generally be weak.  If the dollar is weak (i.e., is losing value against currencies with which it trades), commodity prices will be strong.  Within reasonable parameters, the supply of corn harvested in the US in any particular year is far less important to determining its final price than is the foreign exchange value of the dollars in which it is priced.  The 2008/2009 price spike and then plunge in agricultural commodities can be almost wholly attributed to the foreign exchange value of dollars.  Neither supply nor demand for agricultural commodities changed much.  People reliably kept eating, and farmers reliably kept planting, right on through the economic calamity.  The thing that changed was the money.  Dollars were initially losing value internationally, until by something of a queer turn, they gained in value as a safe haven against financial turmoil, in many respects swimming against a strong tide of inflationary Federal Reserve policies.

Consider the following two graphs (both from FRED, the St. Louis Federal Reserve data base), the first of the trade-weighted dollar index against major currencies over the last ten years:

 FRED Graph

The decline in dollars internationally during the early part of the last decade yielded a steady increase in prices paid for intermediate foods and feeds, as the next graph indicates(the graph is for domestic producers, but it serves as a good example of what the markets were doing overall).  Inflationary hysteria (declining dollars and spiking commodities prices) reached a peak just before the near collapse of the financial system, which then caused the dollar to rise, and agricultural commodities to fall, as money the world over sailed into the safe harbor of the US dollar:

 FRED Graph

The subsequent increase in agricultural prices, to a level even higher than was reached at the previous peak, can be attributable to the effects of massive increases in the supply of dollars due to Federal Reserve machinations, and to a collective sigh of relief internationally that it did not appear the world was soon ending due to the financial crisis.   Agricultural commodities were among the first to recover in price.  People kept eating.  Money harbored in dollars gradually left port, and the dollar consequently declined in value internationally, while the Fed flooded the world with dollars, successfully achieving the goal of cheapening their value.

But the interplay between the exchange-traded value of dollars and the international commodities markets can only tell in which direction the general price level for internationally traded commodities like corn and wheat and rice and cotton should point.  Individual commodities will be priced according to their individual supply and demand metrics.  If corn prices go up relative to other agricultural commodities, particularly relative to those that might serve as feasible substitutes for corn (wheat, rice), then it is clear the market thinks corn supply is out of equilibrium with corn demand.  This is precisely what has happened, as the following excerpt from a report by the United Nation’s Food and Agriculture Organization  makes clear (the rest of the world, except the US, refers to corn as “maize”):

The FAO Food Price Index (FFPI) averaged 213 points in July 2012, as much as 12 points (6 percent) up from June, but still well below the peak of 238 points reached in February 2011. The July surge of the Index followed three months of decline. The sharp rebound was mostly driven by a jump in grain and sugar prices, and more modest increases in oils/fats. International prices of meat and dairy products were little changed.

 The FAO Cereal Price Index averaged 260 points in July, up 38 points (17 percent) from June and only 14 points below its all-time high (in nominal terms) of 274 points registered in April 2008. The severe deterioration of maize crop prospects in the United States, following drought conditions and excessive heat during critical stages of the crop development, pushed up maize prices by almost 23 percent in July. International wheat quotations also surged (by 19 percent), amid a worsening of production prospects in the Russian Federation and expectations of a firm demand for wheat from the livestock sector for the second consecutive season because of tight maize supplies. By contrast, international rice prices remained mostly unchanged in July, with the FAO overall Rice Price index stable at 238, barely one point more than in June.

Behold, a market working as it should, and quite remarkably so.  Agricultural commodities enjoy truly globalized markets.  The corn planter in Russia enters the market for his wares on roughly the same footing as his counterpart in Iowa.  If there is more aggregate worldwide demand for corn than is being supplied, the price will rise.  If it rises to a point that covering the cost of substituting some other commodity for corn is feasible, then demand, and concurrently, price, will quit rising at that point.  The myriad factors affecting supply and demand mean that markets, while always trending through the price mechanism to equilibrium, only occasionally and temporarily ever achieve it.  It is a marvel that the demand for foodstuffs is practically always supplied the globe over (i.e., famines are rare and localized, almost always the result of wars or conflicts, or feckless government meddling), and that the market mechanism by which such a feat is accomplished is not the product of any deliberate human design, but is a pricing mechanism arising more or less spontaneously to meet human needs.

So far as the scary images of shriveled stalks of corn, it might be instructive to remember another recent supply scare with another important agricultural commodity.  In 2011, the peanut harvest was also down roughly thirteen percent (much as are corn and soybeans this year) due to hot, dry weather in some growing regions (mainly Texas and Georgia), and consumers were warned to expect price spikes and shortages of peanut butter (see Yahoo! article).  But that wasn’t the real story.  Hot and dry weather had only a small impact on the peanut harvest.  The biggest impact came by farmers switching to cotton, as cotton prices had soared the previous year.  In 2012, farmers switched back to peanuts, as the cotton price plummeted due to oversupply arising from the switch.  While the price of peanut butter increased about 30% after the 2011 harvest, like corn, there are substitutes in the diet for peanut butter, so presumably no one starved for want of a jar of peanut butter.  They simply had to pay a bit more for the pleasure if they wished to stick with PB & J’s.  Georgia, far and away the biggest peanut grower in the US (producing about half the national total), is expected to roughly double its harvest of peanuts this year from last, farmers there having planted almost twice the acreage as last year (475,000 acres last year–the lowest since 1982–to 710,000 acres this year, according to an article in the Chattanooga Times).  As always, in a properly functioning market, the cure for high prices is high prices.  Peanut prices will undoubtedly crater from their record levels of last fall.  They’re already down to around $650 per ton this year, where they topped out at roughly $1,000 per ton last year.  It wouldn’t surprise to see them touch the $355 per ton minimum set by federal price supports.

There are a myriad of factors which will determine whether the relatively small corn harvest this year causes price increases at the corner grocery.  While corn factors in the food chain (and now, energy chain, through ethanol) in a number of ways, from corn syrup to corn oil to corn meal, etc., it is not indispensable except for just a few end uses.  Like peanut butter can’t be produced without peanuts, creamed corn (yuck!) can’t be canned without corn.  But consumer dietary preferences can readily adjust to discretely identifiable price increases, substituting rice or wheat or potatoes, etc., for corn.  And if corn gets too expensive for industrial users, from bakeries churning out tortillas, to soda drink bottlers packing sodas, there are alternatives to corn. 

It is only when prices rise across the board that substitution is ruled out.  If all agricultural commodities increase in price, it will be the least of the consumer’s worries that corn products are differentially a bit more expensive than other products that are also more expensive, just not by as much.  The US Federal Reserve has been following the prescriptions for reducing unemployment offered by John Maynard Keynes nearly to the letter in trying to lower the stubbornly high rate of joblessness, desperately seeking to decrease real wages by devaluing the currency (i.e., inflating prices for goods and services).  You can bet that if it succeeds in the next few months in lowering real wages through inflating the price of everything that wages might buy, it will cynically claim that it was the poor corn and soybean harvests that caused the economy-wide inflation.  It will be a lie, but then lies and delusions are the coin of the realm for central bankers. 

More likely, by late fall or early winter, the Fed’s inflationary designs will again be thwarted by international turmoil, particularly in Europe, as foreign currency will scurry back to the relatively safe harbor of dollars (while the Euro very likely will disappear as a currency union, the US is not yet in any danger of doing the same).  Agricultural commodities might spike a bit higher just before they crash again, similar to what happened in 2008/2009.  It may very well be the case, no matter how few corn and soybeans finally make it to market, that within a year, those 23% higher futures contracts end up making some corn and soybeans sellers rich, while prices at the corner grocery increase very little, if at all. 

If people better understood the agricultural markets and the role the Federal Reserve plays in them, instead of flashing shriveled fields of corn across the screen when hot and dry weather means the crop might come in short, the fear-mongering newscasters would flash Ben Bernanke’s scruffy visage across the airwaves.  Mother Nature is predictability unpredictable in aiding or thwarting mankind’s survival imperatives.  A vast system of countering her arbitrary and capricious nature arose more or less spontaneously, with only sparing help from governments, to ensure that demand was amply supplied, the incidental effect of which was bad weather in one locale didn’t necessarily mean the locals starved.  While Bernanke hasn’t yet so deleteriously monkeyed with the market machinery of food supply meeting food demand via the conveyance of  reliable pricing information that people starve because of Federal Reserve policies (though Egyptians, et al, probably got a revolution for the trouble), if he continues with his tinkering, the price signals upon which markets depend might become so unreliable as to make marrying supply with demand effectively impracticable, again subjecting people to suffer in their bellies the vicissitudes of Mother Nature’s local wrath.

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