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Let Them Eat Rice

Washington's unedifying ethanol food fight.

12:00 AM, Jul 25, 2008 • By DAVE JUDAY
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A study entitled The Effects of Ethanol on Texas Food and Feed by the Agriculture and Food Policy Center at Texas A&M University (TAMU), often cited by the "ethanol-doesn't-cause-food-inflation" crowd because one of the conclusions is "this research supports the hypothesis that corn prices have had little to do with rising food costs," also avers "it would appear that this research supports the hypothesis that the transition in livestock prices and margins has yet to move through the system." In other words, the dramatic impact of record priced feed corn has yet to be fully felt by the consumer. The worst is yet to come.

Consider the meat sector--meat purchases alone account for more than two percent of the total Consumer Price Index (CPI). To date it has been the cattle feeding industry, the meat packing industry, and the rancher and cow-calf farmer absorbing the shock of record corn prices. Indeed, there is a large supply of meat on the market right now--in part, it is worth noting, because high corn prices have made it too expensive to keep beef alive on the hoof versus slaughtered and in the cooler. But as the current cold storage meat supply dwindles, the more expensively raised cattle will be harvested, and the retail impact will be felt.

Premier livestock analysts Len Steiner and Steve Meyer from the CME Group note one very key historic precedent: "the last major change in corn prices was followed by the first major change in food, meat and poultry costs since World War II." Corn prices back in 1973 jumped 67 percent over the previous year, establishing a new plateau--much as ethanol is driving food prices to a new, higher plateau now. Food inflation set a record that year, and continued rising an average of 8.2 percent from then to 1981 when it began to stabilize. Average food inflation the past 10 years has been 2.3 percent, by comparison; over the past 12 months, it has been 5 percent--since the implementation of the RFS, food inflation has been 8.67 percent.

The TAMU study is instructive in putting into context the various econometric machinations used in this debate. That study provides this caveat: A weakness of our approach is that the historical data are just that, and as such our measurements do not fully reflect the structural change that has been taking place in recent years. Indeed, economic modeling--more art than science to begin with--is a backward looking discipline. That is a problem, as biofuels have changed the commodity supply and demand balance as we know it. Indeed, what econometric model based on historical data could accurately predict and analyze the ramifications of record high prices coupled with a record large crop? That tandem has never happened before.

Moreover, corn has never faced a demand as inelastic as biofuel use. The law mandates the utilization of at least one in every three bushels of corn--no matter the price, no matter the overall supply available--for fuel feedstocks. And consider, the more inelastic the demand, the more impact on price, so goes the economic theory behind the model.

When Secretary of Agriculture Ed Schafer said in May, that the RFS "is not a major factor" in food inflation, he placed himself in opposition to some very fundamental principles of economics. When he said in June, "there is no evidence that we can find that changing the renewable fuels standard or moving away from corn-based ethanol production would make any difference in the price of food and foodstuffs in our country," one has to conclude they weren't even looking for such evidence.

Dave Juday is a commodity market analyst.