Last week, I travelled through the drought-stricken areas of Illinois, Missouri and Kansas to see the devastation among the cornfields in person. The pictures on television don’t do it justice. There is something heartbreakingly overwhelming about miles and miles of crispy, brown cornfields, baking in 100 degree heat with no relief in sight – not only the crops, but the ditch weeds and the trees lining the Interstates – all of them dry as tinder, stressed in the drought. Some of the trees are already losing their leaves; some are dead.
What does this mean for us, the consumers of corn flakes, hamburgers, and gasoline?
As Nate remarked in his article, we will see higher prices for corn and products made from corn. That includes meat, because most corn is fed to cattle and hogs. It also includes a portion of the price of gasoline, because some gas is blended with ethanol, which is made from corn.
Commodities such as corn, wheat and pork bellies are traded in our instantaneous, global marketplace in such a way that the delivery price for the corn in the ruined crop of 2012 was set something like two years ago…before the seed for the crop was ever sold to the farmers! I kid you not.
I stress this point to the Keynesians and the Austrians: academic theories do not take into account all the ways in which transactions actually occur. Nor do they take into account all the various growing zones in which farmers have more or less days in which to plant their crops, to re-plant the crop if disaster happens early, to plant a second crop during the same growing season, to market or to withhold the crop from market in order to receive a better price. Nor do they factor in all the various traders and speculators through whose (figurative) hands the product passes before it is delivered to its final buyer.
Trades made on the commodities exchanges are a form of gambling. And, as in all betting, one may hedge. Hedges in commodities trading are made in the form of “puts” and “calls.” This is somewhat complex to explain in just a few words, but basically what the trader is doing is betting that the price of the commodity at some future time of delivery will be either higher or lower than it is at the moment he makes the trade.
Whatever you personally think about this system, it has been in operation for several centuries in one form or another. And it works, because the farmer gets the best price he can whenever he decides to sell his grain. He gets his investment back in time to re-invest in the next crop.
The middlemen assume the risk of the gambling/trading as well as shipping and delivery to the final customer – which could be as much as two or three crop-seasons after the harvest. And the final buyer of the commodity gets the best price he can get, depending upon whether or not his purchasing agents have been hedging their bets in the market adroitly.
So what does all of this have to do with corn as a commodity?
Most corn grown is “feed corn” intended to be fed to livestock or to be used to make ethanol —and not fit for human consumption. Individual farmers decide at the beginning of each crop year how much of their acreage they will plant in each type of corn. They follow the commodities trading reports very closely to help them to figure out which types of crops will be the most profitable to plant each year. Of course, all of the corn has been affected by this year’s drought.
Humans can only eat a certain type of corn. Corn destined to be used for human consumption – for corn flakes, say, or corn syrup added into soft drinks – will have the longest-range effect upon our wallets. The corn has to be dried and then ground into flour or meal or pressed into syrup before being processed into whatever form is necessary for use by General Mills ™ or Coca-Cola ™.
Thus, the speculative pricing – all that panic-induced trading spurred by news of the drought in the Midwest – will push the price/bushel of corn upward for the 2012 corn, and for the 2013 corn and the 2014 corn (which of course hasn’t even been planted, yet). Those prices will waver up and down until the month and year of actual delivery – and their puts and calls will vary accordingly – but the upshot is that consumers of edible corn will feel the pinch in the grocery stores for several years, as the manufacturers pass along their added costs.
Meat pricing will be a little different. In fact, you might already be seeing a reduction in the price of beef and pork as livestock is sent to slaughter early because ranchers and farmers know that the price of feed corn will increase due to the drought. They are thinning their herds down to breeding stock in anticipation of higher feed costs. Take advantage of the sales and fill your freezer. The price of meat will rise later as scarcity hits in 2013.
There is a movement afoot in Congress to “ease” the ethanol blending regulation to lower than 10%, another factor in the traders’ minds to figure into their speculation on corn futures. Oil prices generally fluctuate before an American election, depending upon what OPEC wants to happen. The price of gasoline in this country has a very strong speculative component to it both from the price of oil and from the price of the corn to make ethanol. This one is nearly unpredictable.
The question we haven’t asked is this one: is the drought of 2012 a one year phenomenon?
Part of the reason corn prices for 2013 and 2014 are on the rise is that the smarter speculators know that droughts run in cycles and are seldom broken in a single year. If you look at weather patterns back through the Dust Bowl, that’s true. Buckle in for a long siege.