The Economist magazine again placed a macro issue on its cover. This time it is highlighting the commodity markets. The focus is on grains. We have just written about why grain prices are high, but as we have seen in the past, if an issue makes it as a cover story on a business news magazine, there is a good chance for a price reversal. See last week on the match between a cover and the rise of the dollar.
We will be in a volatile period for grains until we have a better idea of the South American harvest, yet the level of current grain prices seems high versus historical standards. Nevertheless, it is hard to determine what history can tell us given the significant changes in the grain marketing structure. The ethanol craze has certainly placed more demand pressure on prices than we have seen five years ago.
Ethanol is a new form of subsidy for farmers but it has greater negative impact on consumers. When we pay farmers not to plant in order to raise prices, we are taking out capacity that can be used later. Any supply shock can be resolved over a growing season. However, when we provide corn subsidies for ethanol, the grain is grown and taken out of the food consumption stream. This production cannot be diverted into add to inventory without having a major impact on the ethanol industry. We will be asking very soon about what were people thinking by developed corn ethanol. The trade-off of food for gasoline does not make sense.
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