Fuels versus Food: Is it Rhetoric or Reality? By Terry Francl, Senior Economist, American Farm Bureau Federation ®
Hardly a day passes without reading an article or hearing a report that higher corn prices, due to the increased demand for ethanol, are causing higher food prices. Yet these reports are generally vague about the specific connection. In fact there is little evidence that higher corn prices have raised consumer food prices.
Last November I published an article looking at the possible impact of ethanol and higher corn prices on food prices. The basis for the article at that time was an economic analysis done in conjunction with the Food and Agriculture Policy Research Institute (FAPRI) that showed little impact from ethanol on food prices in 2006 and 2007 and then a 0.2% rise in the food CPI price index 2008. In 2009, the food CPI would rise 0.5% and then the next three years the food CPI would be 0.7% higher then would otherwise be the case.
It should be emphasized that these numbers are for the food CPI which accounts for just under 14% of the weighting for total CPI. So if the food CPI should increase at a 0.7% rate it would add only 0.1% to the total CPI. This could hardly be characterized as an explosion in inflation. Indeed, food and energy are usually separated from the rest of the economy in reporting what is defined as the “core” rate of inflation. Food and energy are deemed to be volatile and subject to rapid changing supply and demand conditions due to weather (food) and geo-politics (energy) that do not necessarily reflect the underlying “core” inflation rate.
So much for theory, economic models and the long-term outlook, what has happened in recent months and what is happening today? Have higher corn prices caused a rise in the food CPI?
It is important to understand exactly how higher corn prices may affect the food CPI. Some 99% + of the corn raised in this country is field corn that is utilized for feed, export, ethanol and a few consumer related products lumped under the category of industrial. For the current 2006/07 corn crop year the respective numbers are 50%, 19%, 19% and 12%. Even the 12% number overstates the amount utilized in the food sector. As the title indicates some of it goes to industrial products and a small fraction into biodegradable plastics. However, the largest single use in this category is for high fructose corn syrup (HFCS), utilized primarily as a sweetener in the soda industry and in the bakery sector.
The bulk of corn consumed by humans (50%) comes via the meat and dairy sector. As the price of corn rises it increases the cost of feeding an animal or bird until it becomes unprofitable. After suffering a loss for a long enough period of time, producers decide to adjust their production downward. Ironically, in the short term this can actually increase the amount of meat being offered to the consumer as producers liquidate a portion of their herds or flocks, resulting in lower meat prices.
At some point the production of meat, milk, etc., is reduced. The farm price of that commodity will
eventually rise to a higher level that makes production profitable and induces producers to expand production, renewing the cycle.
It should be noted that there is an enormous difference in the lead-lag time associated with the adjustments of the various bird and animal sectors. It is a function of the time it takes for gestation and raising the animals or birds. The adjustment of chickens may be a matter of a few months, while the beef sector can take 2-3 years. Hogs take approximately 12 months.
The rate of increase in red meat supplies has indeed been reduced the past couple of quarters, but this is a process that has been going on for over a year, long before corn prices increased last fall. Red meat supplies increased 4.9% over the year earlier period in the first quarter of 2006, but had dropped down to a 3.4% year- over-year rate by the fourth quarter of 2006. This is a significant increase in production and as a result the average price farmers received for their cattle and hogs declined 2.1% and 5.5%.
During the first quarter of 2007, approximately four months after corn prices began to increase, red meat production rose at a 2% rate and is forecasted to increase at slightly more than a 1% rate the next couple of quarters. There has been no significant increase in read meat supplies. In other words, there is little evidence of any ethanol induced liquidation shy of anecdotal reports of cow/calf sales due to drought in the West and Southeast. While feed costs are higher than a year ago, in general, they are not so high as