It looks like the 2014 harvest of major field crops like corn and soybeans is going to be very large. It certainly will approach previous records and may set new ones.
That is bad news for crop farmers since prices have dropped sharply just since planting and are now well below levels that prevailed for the past several years.
Moreover, for a sector in which land rental rates and purchase prices have soared for seven years, this is a scary portent.
It is good news for livestock producers, however, so the farm sector isn’t entirely gloomy. And it’s good news for the global economy as a whole; more food being preferable to less.
It is good for consumers who may see some easing of margarine and cooking oil prices quite soon and of meat prices down the road.
It is also good for economics professors, because it illustrates many of the key concepts in a microeconomics course and a few from macro, too. Let’s look at some of them.
The basic situation stems largely from supply, but demand factors also play a role.
Supply involves the willingness of producers to offer for sale different quantities at different prices.
Higher prices bring forth larger quantities, lower prices smaller ones. But what happened in recent months is a “supply shift,” a change in some related factor that changes the quantities producers offer at any given price.
That “supply shifter” is favorable weather. Although there was drought and flood damage in a few areas, most key growing areas for field crops have had very favorable weather.
So, over the coming months, at any given price, farmers will be willing to sell greater quantities of corn or beans than they would have at the same price last winter or two years ago or five years ago.
The price drops have been large.
Farmers in southern Minnesota can now get about $3.35 per bushel for corn versus $4.50 last March and over $7 a year before that. Prices have fallen by 50 percent in 14 months.
However, it is not that the new crop is twice as large as the previous one, or even 50 percent greater.
The changes in quantities available for sale or those actually used have changed by only a few percent.
This illustrates what economists call “inelastic” supply and demand.
“Elasticity” relates the percentage change in quantity of either supply or demand to the associated change in price. When a large change in price causes only a small change in the quantity users buy, demand is “inelastic.” When supply is inelastic, a small percentage change in quantity causes a much large percentage change in price.
That is what is happening now. Inelastic supply means that even though prices have fallen by half, farmers are still going to offer a lot of grain for sale. But because demand is also inelastic, lower prices are not going to motivate grain users to dramatically increase their usage. So price suffers a double whammy.
Indeed, there are independent factors on the demand side that contribute to falling prices. Asia is a major importer of U.S. crops. The Japanese economy has well-known problems. The outlook for the Chinese economy, for years the source of great growth in demand for ag products, is decidedly more somber.
Europe is still an important customer and its economy is in poor shape also, with the European Central Bank struggling to fend off deflation. Europe will still buy a lot from us but, here again, small quantity changes have big effects on price.
So far, the discussion has been microeconomics. But macro enters into export sales. Japan is following a monetary policy to push down the value of the yen relative to other countries. It is successful and the U.S. dollar is “stronger” compared with the yen than before. The result is that $10 worth of U.S. corn or beans would have cost a Japanese buyer 977 yen at the end of August, 2013, but 1,040 yen on the same date this year. That 6.4 percent price boost inhibits U.S. export volumes.
Relative to the euro, there is no change compared to a year ago, but over longer terms, the effect of a stronger U.S. dollar is similar to that of Japan. For example, the cost in euros of a given dollar value of U.S. farm products is 10 percent higher than at this time in 2011.
Moreover, while the European Central Bank is committing to lower interest rates, and hence a lower-priced euro, the U.S. Federal Reserve is reaching the point where it will raise rates. This will make the dollar even higher-priced relative to both the euro and the yen, to the disadvantage of U.S. agriculture exports.
The big macro question is what sharply lower crop prices combined with inevitable Fed tightening of U.S. monetary policy will do to farmland prices. The prices of several classes of assets have run up sharply over the past five years, but none as sharply as these. Part of that is due to very high commodity prices until recently, driven in great part by growth in China. Part is due to extraordinarily low interest rates driven almost entirely by Fed policy. Everyone following this knows that current price levels are unsustainable unless commodity prices remain very high and interest rates extremely low. Both now are poised to head in the wrong direction. The question is how much that will lower land prices.
My own guess is quite a lot. My family owns some 211 acres of not very good farmland. But I wouldn’t be surprised if by this time in 2016, that land has a paper value a quarter of a million dollars less than it does now. Since it ran up by much more than that over the past five years, such a drop would fit an old economic model: “easy come, easy go.”