What is driving the price of commodities and the price of food?

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Farmers have long been willing to produce for the market, and farm programs over the past 20+ years have moved agriculture from a managed supply to a market oriented pricing system.  But when you produce for the market, you don’t always know who is going to come to buy.  While the American consumers have been the primary force, they are being supplanted by Chinese consumers.  And while American farmers have worked long hours to build markets for their products, the ethanol success story has also become a driving force beyond consumers and livestock.  So the adage “Be careful what you ask for, you may get it” can certainly be applied to US agriculture, and with some surprising results.

At the request of the Farm Foundation, Purdue economists Wally Tyner, Phil Abbot, and Chris Hurt took up the challenge of defining what is driving US food prices in 2011.  Their analysis of identifying what is pushing food prices brought several dynamics to the forefront.

  1. The market has seen two major players have a larger impact than any other, and both are familiar to farmers.  China’s demand for corn, as well as soybeans, has shifted from rumor to fact, due to its growing and hungry population which has the money to spend on better food.  The other is ethanol, which shifted from a background consumer of corn to front and center when Congress approved the biofuels mandate.
  2. The economists, in economist-speak, say another dynamic is the fact that markets are more inelastic than they used to be, and have become more volatile when such consumers as China and biofuel come to the market and make headlines.  And the inelasticity is worsened because of all of the forces are having a bigger impact on the market than they used to have.
  3. A third dynamic is increasing weather events that have adversely affected yield and the impact they have had on stocks, which have been slowly declining.  Subsequently, the low stocks to use ratios that are becoming prominent in market reports are having a greater impact on market prices.
  4. China shows up in another way, which is how it manages its supplies of grains and its difficulty addressing internal issues of self sufficiency.  While China imports most of its soybean needs, its other food needs are largely disconnected from world markets.
  5. The fifth factor is the collection of other macroeconomic factors that push and pull on the market, not the least is the exchange rate and the dollar’s value compared to other world currencies which fluctuates daily.  With a weak dollar, and a volatile relationship with other currencies, from one day to the next it will either throw water or gas on a fire that is the US commodity market.

The Purdue economists also look at the reasons which have brought these drivers to the forefront.  Among those are:

  1. The ethanol mandate and other biofuels policies that have resulted in a corn demand that has not responded to market pricing.  The nation’s fuel supply is supposed to have ethanol, and that demand must be met regardless of the cost of making it.  But because of the fact that corn-based ethanol has reached its maximum content level in motor fuel, there should be very little additional force that it puts on the market.
  2. Chinese income growth bolstered its demand for food but also China has been building its own grain stocks which have fostered more purchases than necessary.  Depending on the continuation of that stocks policy, China’s rate of food purchase may slow when the country decides its stocks are at sufficient levels.
  3. Depending on demand for certain crops, land is reallocated for their production.  If China and ethanol refiners want more corn, then land will be allocated for corn instead of other crops which may provide a lesser profit potential.  The Purdue economists say in 2005 it took 16 mil. acres to supply China and ethanol, but in 2010 it took 46.5 mil. acres to do the same.
  4. Due to the inelastic market, and the trouble it has responding to the increased demand, other factors have aggravated the situation including trade policy, greater demand for livestock feeds, and tight food stocks, such as livestock producers having to pay more for feed.  The latter has resulted in production cutbacks.

The Purdue economists say the current year may not allow a return to periods of robust stocks because of the weather, and global stocks will remain tight with corresponding higher prices. 

However, they cannot identify whether the market is shifting upward or whether we are in a boom or bust cycle, which cannot be determined until other economic factors are clearer.
They do speculate that removal of the ethanol subsidy program would have more impact on the refiner and the blender than on the farmer growing corn, and lower oil prices would have a significant impact on the ethanol economy.  They also suggest that shifting US farm policy from one that reduces supply to stimulating supply would result in benefits that would not happen if demand were not subsidized by either taxpayer funds or policy mandates.

Summary
Significant drivers in the current US food economy have been China and biofuels, but because the market has been unable to easily respond to those major consumers, other forces have pushed and pulled on commodity prices more than would have been expected, such as weather and the exchange rate.  Food and feed supply and price pressures might be relieved with changes in agricultural policy that remove subsides for using commodities and replacing them with policies that promote more production.

Source: the FarmGate blog


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