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Thread: law of unintended consequences at work ?

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    Default law of unintended consequences at work ?

    from Steve Saville, Speculative Investor -

    (snip) All government interventions designed to improve the workings of the economy have unintended adverse consequences, and in its efforts to bring about a massive increase in the production of ethanol the US Government might have unwittingly set in motion a chain of events that will simultaneously put upward pressure on commodities and downward pressure on financial assets (stocks and bonds). As discussed in previous TSI commentaries, the reason is that increases in grain prices resulting from the surge in ethanol-related demand for these commodities will lead to across-the-board increases in food prices. This, in turn, will likely cause inflation expectations to rise, thus putting downward pressure on bond prices (upward pressure on long-term interest rates) and prompting wage-earners to demand more money from their employers to offset cost-of-living increases. As a result, equity valuations will potentially be hit by the 'double whammy' of rising interest rates and shrinking profit margins."(snip)

    interesting take on the economic fundamentals ! comments ?

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    Default Re: law of unintended consequences at work ?

    Quote Originally Posted by Melonie View Post
    from Steve Saville, Speculative Investor - http://www.safehaven.com/article-7182.htm

    the reason is that increases in grain prices resulting from the surge in ethanol-related demand for these commodities will lead to across-the-board increases in food prices... (snip)
    How significant is the increase in demand for grain!? I think it's a bit far fetccehd to think that an increase in price/demand for on one food item is gonna create significant inflationary pressure! For me, the answer is NICE TRY, BUT NO

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    Default Re: law of unintended consequences at work ?

    I don't suppose that some facts would help influence your assessment ?







    (snip)"According to the United States Department of Agriculture, this year the country is going to use 18 to 20 percent of its total corn crop for the production of ethanol, and by next year that will jump to 25 percent. And that increase, says Marshall Martin, an agriculture economist at Purdue University, "is the main driver behind the price increase for corn."

    The jump in corn prices is already affecting the cost of food. The most notable example: in Mexico, which gets much of its corn from the United States, the price of corn tortillas has doubled in the past year, according to press reports, setting off large protest marches in Mexico City. It's almost certain that most of the rise in corn prices is due to the U.S. ethanol policy, says David Victor, director of the Program on Energy and Sustainable Development at Stanford University.

    The rising food costs fueled by ethanol demand are also affecting U.S. consumers. "All things that use corn are going to have higher prices and higher cost, to some extent, that will be passed on to consumers," says Wally Tyner, professor of agriculture economics at Purdue University. The impact of this is being felt first in animal feed, particularly poultry and pork. Poultry feed is about two-thirds corn; as a result, the cost to produce poultry--both meat and eggs--has already risen about 15 percent due to corn prices, says Tyner. Also expect corn syrup--used in soft drinks--to get more expensive, he says.

    The situation will only get worse, says David Pimentel, a professor in the department of entomology at Cornell University. "We have over a hundred different ethanol plants under construction now, so the situation is going to get desperate," he says. "(snip)


    So there's your answer ... a 25% diversion of corn production to ethanol production next year, with yet higher percentages of diversions of corn to ethanol called for in future years (see chart at the beefusa link). When you 'pull' 25% of the available supply from any market, the price increases by way more than 25% (in the case of corn the price has almost doubled ... so far). Thus every other business that requires corn as an 'input' i.e. cattle / poultry / breads plus indirect applications like sweeteners sees a production cost increase ... which must either be followed by a price increase for their downstream product i.e. beef / chicken / eggs / cola or a huge squeeze in profit margin.

    At the same time, since the huge additional ethanol demand and very high prices for corn now exists, it creates competition on the basis of acreage. In other words, if a farmer can get twice as much money from planting corn as he could get from planting soybeans or tomatoes, there are definitely going to be fewer soybeans and tomatoes available. As a result, the prices of EVERY US farm product is going to increase across the board based on shortages created when farm acreage is diverted into corn and out of these other agricultural products.

    At the same time, workers faced with rapidly rising prices for beef / chicken / eggs / cola / corn bread = tortillas soon start demanding pay raises to compensate for their higher costs of living. This puts even more labor cost pressure on all businesses, cuts even more deeply into their profit margins, and precipitates even higher price increases for their products (which may or may not have anything whatsoever to do with food or ethanol, but simply contain soon to be higher priced labor).

    Basically, with the advent of increased demand for corn as an ethanol feedstock, essentially all of the highly productive US farmland is now being used to grow 'something', be it corn or another agricultural crop. Further increases in demand for corn as an ethanol feedstock creates a 'shortage of acreage' in terms of highly productive farmland. This shortage of 'acreage' has first affected food products available for export - leading to a 400% increase in Mexican tortilla prices per the recent UKRegister link. Next it will prompt the active farming of previously unfarmed 'marginal' cropland in order to meet the needs of both the ethanol/biofuel segment as well as the food segment. However, the additional costs of fertilizing, irrigating, plowing / harvesting lower yield crops from 'marginal' farmland will also be passed on in the form of even higher prices across the board for agricultural products of all types.

    If the near doubling in the production cost of direct corn based products plus the 15% increase in cost for producing beef / chicken / eggs / soft drinks etc. that has already been realized by those producers is passed on to US consumers, plus perhaps a 5% increase in production costs for all non-food non-ethanol US businesses based on rising labor costs alone, one would argue that this is highly inflationary.



    ~
    Last edited by Melonie; 04-04-2007 at 09:07 AM.

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    Default Re: law of unintended consequences at work ?

    Huge jump in corn planting expected -

    There are some interesting comments left by corn farmers about this article as well.

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    Default Re: law of unintended consequences at work ?

    Quote Originally Posted by T-10 View Post
    Huge jump in corn planting expected -

    There are some interesting comments left by corn farmers about this article as well.
    Yup there you go ... a 10% increase in acreage devoted to corn, at the expense of a decrease in acreage devoted to Soybeans. Ethanol demand will keep the corn price high, and a 'shortage' of soybeans will cause their price to rise as well.

    also ...

    "Well put MasterFarmer, agree with you 100%. I own 1600 acres in North-Central Iowa (1000 in corn and 600 in soybeans). It looks like we are going to have some very profitable years ahead of us thanks to the ethanol boom. I forward priced corn at $3.92 a bu and beans at $8.23. An average yield and goverment payments should give me a profit of over $500,000 for the 2007 crop year. Consider that the land has increased in value by $800 an acre in the last year (due to ethanol) in our area which is 1.2 million. It looks my net worth will increase by 1.7 million dollars in one year. Let the city people eat cake, rather than corn. (Made that up myself, didn't borrow the saying from that French woman). LONG LIVE CORN AND ETHANOL."

    ^^^ which is basically made possible by the income taxes of working Americans being transferred to farm subsidy payments, plus 5.6 cents per gallon in stealth ethanol tax on E90 gasoline which is collected from every poor stiff at the pump and transferred to the ethanol refiners to artificially increase the price of US ethanol and corn (in order to keep out lower cost imported sugar cane ethanol from Brazil etc who don't receive the stealth tax 'kickback').

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    Default Re: law of unintended consequences at work ?

    Quote Originally Posted by Melonie View Post

    ^^^ which is basically made possible by the income taxes of working Americans being transferred to farm subsidy payments, plus 5.6 cents per gallon in stealth ethanol tax on E90 gasoline which is collected from every poor stiff at the pump and transferred to the ethanol refiners to artificially increase the price of US ethanol and corn (in order to keep out lower cost imported sugar cane ethanol from Brazil etc who don't receive the stealth tax 'kickback').
    Somehow I seriously doubt you have even the slighest concern for the people you defined as poor stiffs. You would thumb your nose up at ANYTHING that threatens fossil fuel company profits because you yourself make money from those stocks.

    But I digress, here are some other comment from the link which addresses you above reply -

    ' The purpose of goverment subsidies in agriculture is to provide a stable and cheap food supply to the people of this country. With out these subsidies the price of food would have as many ups and downs as crude oil. This country spends the least amount of money as a percentage of income on food, than any other country in the entire world. Even though you are not a farmer, you are in fact also recieveing some of this by the cheap food policy our goverment likes to maintain. History has taught us that a well-fed society is much more productive and easier to govern than a hungry one. Take away these subsidies and your price of food will at least double.'


    ' Fact: The 2006 inflation adjusted price per bushel of corn in 1974 was just over $14 per bushel. We raised plenty of cows and fed alot of people at that price. The sky never fell on us. People just purchased less music CD's, videos, and internet services to pay for their low cost quality meals from the good 'ol USofA corn farmer.

    Now subsidized corn prices of $2.00 per bushel have recently increased to $4.00 per bushel (in 2006 dollars). '
    Last edited by T-10; 04-05-2007 at 09:47 AM.

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    Default Re: law of unintended consequences at work ?

    ^^^ so there is an easy fix for the problem, from a financial standpoint - and it doesn't involve oil companies it involves common sense.

    Repeal the US import quotas and stealth 56 cent per gallon tax on ethanol sold in the USA !

    The 3.50 per gallon US price of ethanol can be immediately reduced to the below 3.00 a gallon price of Brazilian ethanol if the removal of quotas allowed for unlimited imports. Between these two measures, the price of E90 blended gasoline in the US would drop by more than 10 cents per gallon (5.6 cents/gal on elimination of the stealth tax on E90 gasoline, plus another 5 cents/gal from using less expensive Brazilian ethanol to make the blend).

    Besides lowering the price of E90 blended gasoline, the de-facto substitution of Brazilian sugar cane for US corn would cause the price of corn to drop by reducing aggregate demand for US corn, as well as reducing the price of every other US crop which now competes for America's now fully utilized 'prime farmland acreage', as well as reducing the price of every other foodstuff / product that uses corn as an 'input'.

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    Default Re: law of unintended consequences at work ?

    Quote Originally Posted by T-10 View Post
    Somehow I seriously doubt you have even the slighest concern for the people you defined as poor stiffs. You would thumb your nose up at ANYTHING that threatens fossil fuel company profits because you yourself make money from those stocks.

    But I digress, here are some other comment from the link which addresses you above reply -

    ' The purpose of goverment subsidies in agriculture is to provide a stable and cheap food supply to the people of this country. With out these subsidies the price of food would have as many ups and downs as crude oil. This country spends the least amount of money as a percentage of income on food, than any other country in the entire world. Even though you are not a farmer, you are in fact also recieveing some of this by the cheap food policy our goverment likes to maintain. History has taught us that a well-fed society is much more productive and easier to govern than a hungry one. Take away these subsidies and your price of food will at least double.'


    ' Fact: The 2006 inflation adjusted price per bushel of corn in 1974 was just over $14 per bushel. We raised plenty of cows and fed alot of people at that price. The sky never fell on us. People just purchased less music CD's, videos, and internet services to pay for their low cost quality meals from the good 'ol USofA corn farmer.

    Now subsidized corn prices of $2.00 per bushel have recently increased to $4.00 per bushel (in 2006 dollars). '
    This argument ignores facts

    But then any advocacy of protectionist government subsidies must ignore facts because it's an indefensible position.

    The subsidies are not there to decrease the market price of food. If the USA was the only source of food in the world, this would be the case. But even then, there are better ways of subsidizing food to ensure that the gains are passed onto consumers, not retained by producers

    You've forgotten there is a global food market. Everybody (except USA farmers) would be better off if we didn't subsidize farmers and just imported the food. It's more efficient if we just gave all that subsidy money to everyone (in handouts or tax breaks) and they could decide what to do with the money...

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    Default Re: law of unintended consequences at work ?

    ^^^ agricultural subsidies were instituted by the US gov't long before the days of alternate fuels stimulating huge additional demand. In the 'early days', weather and crop yields were less predictable, and total demand for farm products did NOT require the use of all available US farmland in order to meet that demand. Thus if farmers in aggregate 'guessed' incorrectly in regard to how many acres should be planted with what sort of crops, it was extremely possible that certain crops could wind up with a huge surplus of supply thus a market price below the farmers cost of production. Gov't farm subsidies basically paid farmers to withhold a portion of their acreage from being planted, thus reducing aggregate supply of certain crops, thus reducing surpluses, thus preventing a fall in the market price of that agricultural commodity, thus guaranteeing that the farmer wouldn't have to take a loss vs actual cost of production. Alternate subsidy programs essentially guaranteed that farmers would be paid a subsidized price for their agricultural commodities that was guaranteed to exceed their cost of production. In this sense agricultural subsidies did 'stabilize' the US food supply, albeit at a higher cost in terms of certain agricultural commodities as well as in taxes.

    However, the whole gov't 'regulation' scheme relied on the premise that total demand for US farm products would not exceed the total capacity of available 'prime farm land'. With the advent of the huge new demand as a biofuel feedstock, this is no longer the case. However, many in gov't and on farms have not actually realized the consequences of this change since it occurred in a time period of only two growing seasons as the result of a judge's decision re MBTE liability and a resulting congressional penstroke re ethanol subsidies ! Unfortunately, nobody stopped to do the math in regard to the ultimate production capacity of America's 'prime farm land' versus the ultimate demand for corn based ethanol.

    Today, in essence, the aggregate demand for US farm products now exceeds aggregate capacity of America's 'prime farm land' to produce, which in essence guarantees that there will be no surpluses thus no low prices for any agricultural product. Proof of this fact is the necessary reaction by US farmers / US gov't to 'ration' the available supply. US supermarkets and US ethanol refineries get first 'dibs', with the export market demand for food products then being 'shorted' as a result.

    As the gov't mandate to produce more and more ethanol increases every year between now and 2012, it is a foregone conclusion that export market demand for US food products is probably going to go unserved in order to allocate more and more of US corn production to ethanol. When the demand for ethanol refinery feedstock plus domestic food use exceeds the capacity of 'prime farm land' with no US food production being exported, it will then be necessary to start putting 'marginal farm land' into production. The higher requirements for fertilizer and farm machinery fuel, combined with the lower crop yields, will then spur yet another increase in corn / agricultural product prices as farmers recover their higher costs of production using this 'marginal farm land'.

    This is more or less analogous to 'prime farm land' being a Saudi oil field, whereas 'marginal farm land' corresponds to an offshore oil platform or a stripper well - and future US food prices are likely to follow the historical trend of oil prices once total demand exceeded the available supply from highly productive and relatively low cost sources (which reputedly happened in the early 70's).

    !
    Last edited by Melonie; 04-06-2007 at 03:21 AM.

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    Default Re: law of unintended consequences at work ?

    Quote Originally Posted by salsa4ever View Post
    any advocacy of protectionist government subsidies must ignore facts because it's an indefensible position.
    I doubt that the farmers, especially those who run small farms and barely make ends meat even with the subsidies would agree with you.

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    Default Re: law of unintended consequences at work ?

    ^^^ you are almost certainly correct on this count. Similarly, steel workers, paper mill workers, etc. also advocate the use of gov't subsidies in order to provide them a more 'profitable' paycheck at the US taxpayer's / consumer's expense. And like the farm lobby, steel and paper also really don't care that their 'gain' comes at the expense of other US taxpayers and the expense of all US customers who are forced to pay higher prices for 'protected' steel and paper !



    ... IMHO, any time that gov't decides to enact subsidies or enact tariffs or otherwise create / fund a higher priced 'protected market' for particular producers, a question of basic fairness arises. Is it fair for gov't to spend tax money and/or create higher prices for all Americans in order to provide financial benefits to a fortunate few, while refusing to do the same for producers of different products ? This is the 'moral hazard' of gov't intervening in free markets - which in turn leads to lobbying and a host of other political shenanigans when advocates for certain industries / products try to 'convince' US lawmakers that THEIR industry / product should be the next to benefit from subsidies and/or tariff protection.

    In fairness, it would seem that either ALL US industries should be equal beneficiaries of US gov't subsidies / tariffs / quotas, or ALL US industries should be exposed to the realities of the global economy. Unfortunately, what we actually have is a select few groups of producers benefitting from gov't subsidies / tariffs / quotas, usually in exchange for their having provided political support.


    Circling back to the author's larger point, enacting of subsidies / tariffs / quotas all wind up with the same eventual outcome i.e. higher than necessary tax rates and higher than necessary prices for protected products. Both of these are inflationary, as they rob discretionary dollars from the paychecks of all Americans. This in turn inevitably leads to calls for pay raises, automatic union / gov't paycheck COLA's etc. which increase labor costs, and also inevitably leads to less savings and more borrowing which raises interest rates. Both of these cut into US business profit margins, which is likely to cause a devaluation of company stock shares as well as a reduction in business tax revenues.
    Last edited by Melonie; 04-06-2007 at 05:38 PM.

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    Default Re: law of unintended consequences at work ?

    On a related note- the demand for ethanol production has accelerated destruction of Asian and South American rain forests as farmers clear more land to grow sugar cane and other ethanol producing crops which has a direct, short term impact on local climate and weather patterns.

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    Default Re: law of unintended consequences at work ?

    ^^^ yes, but that's THEIR problem not America's problem in the eyes of the US ethanol / environmental lobby. This is the same sort of logic, with a near total disregard for environmental consequences outside the US border, which has driven efforts by California to drive manufacturing out of the state via super strict environmental laws. As a result, Californians are now discovering that the manufacturing operations which have relocated / outsourced to China are now producing far more pollution than the former operations in California did, and that some 25% of California's current air pollution levels are now directly attributable to Chinese air pollution being blown back to California via the trade winds (over which the state of California and the EPA have no jurisdiction) !

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    Default Re: law of unintended consequences at work ?

    Quote Originally Posted by Melonie View Post
    ^^^ yes, but that's THEIR problem not America's problem in the eyes of the US ethanol / environmental lobby. This is the same sort of logic, with a near total disregard for environmental consequences outside the US border, which has driven efforts by California to drive manufacturing out of the state via super strict environmental laws. As a result, Californians are now discovering that the manufacturing operations which have relocated / outsourced to China are now producing far more pollution than the former operations in California did, and that some 25% of California's current air pollution levels are now directly attributable to Chinese air pollution being blown back to California via the trade winds (over which the state of California and the EPA have no jurisdiction) !
    Not to mention all the CO2 generated by all those Chinese factories.

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