By Jeff Ferry, CPA Research Director
Some agricultural commodities have seen price declines in recent weeks due to uncertainty over international trade relationships.
There is a worrying drop in spot cornand soybeanprices now as the commodity markets react to the trade conflict between the US and China. In the long term, agricultural prices are determined by fundamental forces of supply and demand, such as weather and population growth. Another underappreciated influence on agricultural prices is the foreign exchange value of the dollar. A strong dollar makes agricultural commodity prices decline. A weak dollar exerts significant upward pressure on commodity prices.
The Coalition for a Prosperous America showed that the dollar was overvalued by over 25% last year. It remains overvalued today. A competitively priced dollar – one priced at an equilibrium level – would provide significant upward pressure to agricultural commodity prices and benefit overall farm income. President Trump has instructed Sonny Perdue, Secretary of Agriculture, to find solutions to the harm that the US-China trade conflict is imposing on farmers and ranchers. This paper shows that a policy to move the dollar to a competitive price – for example through a market access charge– could increase corn prices by as much as $1 a bushel and soybean prices by $3 a bushel.
Since the 1970s, studies by agricultural economists have documented the powerful impact of the foreign exchange value of the dollar on farm incomes. . Pioneering research in this area was done in the 1970s and 1980s by University of Minnesota Professor G. Edward Schuh. Schuh published a series of articles using detailed data to show that the health of the US agricultural sector was strongly influenced by the international value of the US dollar from 1949 until the 1980s. Schuh’s work shows for example that the currency devaluations of our major trading partners in 1949 left the US dollar overvalued, leading to an extended period of hardship for US agriculture. Despite price support programs and overseas food aid, farmers suffered weak incomes. Congress’s solution was a government-supported program of land retirement. Some 60 million acres of land were taken out of production over the next two decades. But the land retirement program incentivized farmers to invest in technology to increase the yield of the land still in production, causing yet further overproduction problems. “The overvaluation of the dollar resulted in a larger share of the benefits from the technical change in agriculture being channeled to US consumers than would have occurred with an equilibrium exchange rate,” Schuh said in a 1988 speech
All that changed in the 1970s, when President Nixon took a series of actions that drove down the value of the dollar. Farm incomes took a sharp upward turn. At the time, the strength of the US farm economy was attributed to many things, and especially a wave of Malthusian doom-mongering among economists and policymakers, who were predicting that a population boom in the developing world was creating huge demand for foodstuffs. The doom-mongers claimed this demand would never be able to be met.
Schuh’s later analysis was: “When US actions [Nixon’s floating of the dollar] were combined with the revaluation of the currencies of certain US trading partners, the realignment was of the order of 25 percent in real terms. The result was an agricultural export boom of unprecedented proportions for the United States, a boom which was sustained through to the end of the 1970s…Unfortunately this boom was poorly understood at the time. Many attributed it to the entrance of the Soviet Union into international commodity markets…Domestically, everybody wanted to take credit for the unusual export performance…It was only when the bubble collapsed in the 1980s that the value of the dollar surfaced as the cause of all the difficulties of US agriculture.”
In the early 1980s, the plight of US farmers became nationwide news as land values collapsed, farm income shrunk, and thousands of farmers faced foreclosure. Action by the Reagan administration with the 1985 Plaza Accord to force down the value of the dollar started the agricultural industry on the road back to recovery.
More recently, a 2016 studyby three agricultural economists from Purdue University established a very strong correlation between the prices of corn and soybeans and the value of the US dollar over the period from 1990 to 2013. The study, by Hatzenbuehler, Abbott, and Foster, found very high elasticities for the price of both corn and soybeans in response to changes in the US dollar’s exchange rate against its major trading partners. For corn the figure was 2.53, meaning that every 1% fall in the value of the dollar would, on average, stimulate a 2.53% increase in the price of corn realized by US farmers.
Figure 1. This graph, from the USDA study, clearly shows the inverse relationship between the real (i.e. adjusted for inflation) dollar exchange rate and average food prices.
A studyby the US Department of Agriculture confirmed those high elasticities. This study found that the elasticity for bulk agricultural commodities in relation to the dollar exchange rate was -3.14, a similar figure to the Purdue study. Bulk commodities include meats like beef and pork, as well as grains. The USDA study found a lower elasticity of just -1.06 for consumer-oriented agricultural exports, because there is more differentiation and brand loyalty in consumer products, so a smaller reaction to price changes.
To put this in perspective, between the end of March and the end of June, the dollar’s value against major foreign currencies rose by about 4.6%. That created a downward pressure on bulk agricultural commodities of some 12%, all else being equal. In that period, the spot price of corn fell by some 9%, soybean meal by 13%, and live cattle by 6%. Of course, there have been many other significant weather and political developments in these markets in the last three months, but the effect of the dollar exchange rate does make itself felt.
The economic evidence suggests that a policy of deliberate devaluation of the dollar is very likely to lead to an increase in agricultural prices realized by US farmers, and that will in turn lead to increases in net farm income. For example, a conservative estimate might be that the Market Access Charge would reduce the dollar’s value by some 10% in a year. That could spur an increase in the price of bulk commodities like corn, soybean, or beef of some 25%-30%. After several years of depressed and declining net farm income, that would be welcome news indeed for US farmers. .
Schuh, G. Edward, Macro Linkages and Agriculture: The United States Experience, 1988, pg. 535. Available here.
Hatzenbuehler, Patrick, Abbott, Philip, and Foster, Kenneth, Agricultural Commodity Prices and Exchange Rates under Structural Change, Journal of Agricultural and Resource Economics 41(2), 2016. Available here.
US Dept. of Agriculture, Global Macroeconomic Developments Drive Downturn in US Agricultural Exports, AES-94, July 2016. Available here.