Thursday, August 9, 2012

Drought and Food Prices

The drought that much of the nation’s breadbasket is presently mired in provides a good illustration of the lack of understanding most Americans have when it comes to production agriculture.

Hopeful clouds soar above a field of dryland corn in a field south of Kimball, Neb.
News reports concentrate on the effect the drought will have on this year’s crops – particularly corn – and how a short crop will affect food prices. Unfortunately, the great majority of these reports represent a misunderstanding of both food production and market forces.

While it’s true that in a free market, supply and demand drive prices, the temporary reduction of supply as drought reduces yields this year will only really be felt once the harvest is in, and then only for a relatively short while.

Some may argue that ruthless supply-siders are using the excuse of the drought to jack up prices. But markets don't really work that way. To some extent American markets are less elastic or responsive to immediate real world events than they have been in the past. This is the result of government intervention through policy and regulation. Like it or not, when government enters markets, neither producers nor consumers gain. Everyone loses, in every transaction, at least by a tiny bit.

The present drought, as I said, isn't likely to affect food prices significantly or for a long period. I know, the press says otherwise, and they're "real" experts. So who are you going to believe? The press or your lying eyes?

Here's how it works. The bulk of the cost of retail food lies in post-production processing, storage and transportation. In comparison, the cost of food commodities is quite small and represents only a few percent of the overall retail cost of food at the supermarket. So while the drought will affect commodity prices and therefore a small fraction of retail food prices, it will not affect the other 90-plus percent of factors contributing to retail costs.

Corn is a bell-weather food commodity, and increasingly, a bell-weather energy commodity, yet a 50 percent increase in corn price will ultimately yield only about a one percent increase in retail food costs.

Corn is harvested but once a year, so the corn used today in food production comes from previous crops. Though the present drought has no effect on corn produced last year or earlier, the market does appear to anticipate events, and speculation about this year’s crop is, to some extent, driving a spike in the price of corn purchased today. But markets are mostly self-adjusting. They twitched up at the unexpected news of a possible (or probable) drought-caused yield reduction this year, and they will twitch downward when harvest nears and more certainty about the actual yield provides a moderating influence.

Drought is neither monolithic nor binary. In other words, it’s not an either-or proposition, but one which varies from place to place. In the present drought, a very few producers will have total crop failure, a very few will have bumper crops, and most will find themselves between the two extremes, with their crop affected to some extent but still producing a saleable yield.

The present drought isn’t permanent, and will only bear on food prices so long as it persists. We can’t know the future with absolute certainty, of course, but the past shows us that widespread drought is a statistical outlier. For every season of extreme drought, there is also a season of extreme wet, another outlier. The extremes occur only infrequently, while most seasons cluster around the statistical average and produce average yields. When the present drought eases, so will the temporary spike in commodity prices.

The annual cycle of crop production is a tough concept for many consumers to wrap their minds around, because it is so very different from the way they live their lives. Most don’t consciously understand that for the most part, crops are only harvested once each year, albeit in enough quantity to meet consumer demand until next year’s crop is harvested.

When people are told by seemingly reliable sources that their food security is threatened, they become rightly concerned. The fact that they do become concerned should be appreciated by all ag producers. Those we feed in turn feed us when they buy our crops at the retail level. In a perfect world the press would report objectively and completely on this and other issues. We don’t have a perfect world, though, and it’s extremely hard to counter the narrative.

Still, each of us can do some good by helping our non-ag fellows to understand the present drought and to put it in a reasonable context.

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