The last period of high prices was in 1995 when the season-average price of corn rose to $3.24 per bushel. At the height of concern that 1996 production would not be sufficient to meet demand, 1996 new-crop futures rose as high as $3.83 in July before beginning a five-year decline. It is noteworthy that Chicago Board of Trade corn prices did not indicate that such high prices were permanently with us. Futures prices for the 1997 crop never rose above $3.08 and futures prices for the 1998 crop never rose above $3.00 per bushel. It is clear that traders believed that the high prices in 1995 and 1996 were unsustainable in that a return to normal crop conditions would result in lower prices. A drop in demand caused by the late-1990s Asian financial crises caused prices to drop even further than traders thought likely.
The futures market is telling us a very different story today. Although we are coming off a record corn harvest, the 2008 new-crop corn harvest is more than $5.00 per bushel. The new-crop soybean futures price is more than $12.50 per bushel. In contrast to the 1995/96 high price period, the markets today are not indicating that these record prices are temporary. Farmers can sell their 2009 and 2010 crops for about the same price.
The impacts on agriculture would be staggering if these price levels were permanent. For example, current prices imply that land rents in Iowa and the rest of the Corn Belt should increase by a factor of about 2.8, even after accounting for the loss of government payments, the higher production costs associated with increased demand for inputs, and increased returns to management and machinery. As land rents go, so too do land prices. Iowa State University's annual land price survey showed that in 2005 the average acre of farmland in Iowa was valued at $2,914. That year is a useful benchmark for land values because crop prices had not yet increased. Multiplying the 2005 land value by 2.8 suggests that $5.00 corn and $12.00 soybeans could support average land values in excess of $8,000 per acre.
Crop prices at these levels dramatically increase the cost of raising hogs, finishing cattle, and producing milk and eggs. These costs will have to be passed on to consumers through higher retail prices for meat, eggs, and dairy products to keep livestock producers in business. Competition for land between specialty crops, oilseeds, and food and feed grains will also increase the prices of other products such as hops, malting barley, beans, and vegetables. Consequently, we should expect to see increased food prices over the next year or two as these cost increases are passed on to consumers.
But how much faith should we put in the Chicago Board of Trade as a long-run indicator of price levels, particularly when all the world's farmers face an unprecedented incentive to increase production? How can we reconcile what the markets are telling us with the iron rule of market economics that the cure for high prices is high prices?
Source: Bruce A. Babcock, Iowa Ag Review