There are not such Bubbles in Agricultural Prices

High prices in energy and agricultural products have caused economic problems in the world economy. The consumer prices in OECD area rose by 4.4% in the year to June, the highest inflation rate since March 2000; consumer prices for energy were up by 19.3% year-on-year and consumer prices for food by 6.5%. As consequence, purchasing power of world population has been affected, and the central banks face problems to deal simultaneously with high consumer prices and sluggish economic activity. A hypothesis to interpret this fact is that the increases are as consequence of bubbles in the financial markets.

In Mexico, the first public worry is the rise of food. The prices of bread, cereals and tortillas in the national index consumer prices (published by the central bank) showed a twelve-monthly increased of 12% in June. Bank of Mexico (the central bank), in order to deal with these inflationary pressures, changed its stance of monetary policy to be more restrictive (the central bank rose its target rate 50 base points in the last two months), even though the peso is strong and it seems that economy will expand below its potential.

The hypothesis of high prices by speculative investments in the financial markets consists in that investors buy large quantities of future contracts of agricultural goods, believing that agricultural prices will be high in the future or at least that this investments are less risky. According with the hypothesis, this behavior has pressed agricultural prices to rise above its equilibrium level (those prices shaped by the interaction of supply and demand forces in the market); the spot prices in international markets of wheat and corn rose annually to 56% and 74% respectively. I will attempt to use basic tools of economic theory and some facts to deduce if this increased are result of a bubble in financial markets or if they correspond to fundamental changes.

Increases in prices of agricultural products don’t lead to an automatic increase on supply. Commodity markets have rigidities in supply because their productive cycles are wider than the cycle of other products and services. For example, Jalisco has one period of corn harvested during the year; therefore, an increased in prices as we saw in the last January will affect platend area plans in May-June and hence it will affect the supply ten months later, during the harvest period. These circumstances are replicated in other markets; increases in oil supply take time, for example: according to the Energy Information Administration in United States, open to investments on offshore drilling, given the political pressure to open these areas to produce oil, could take twenty years to reach its production peak, a clear delayed supply response to high prices.

In agricultural markets is expected that in the long run their prices are near to their production cost, and there are temporal variations around the equilibrium price because supply interruption or overproduction causing that producers don’t produce what the consumers want to buy. However, higher costs drive prices to higher level of equilibrium because the supply responds negatively to higher costs. I think it happens even with rational expectations because the future supply, the principal determinant of prices in the short run, has a random component; is unpredictable, causing the prices are unpredictable too. This situation leave to current price as the principal information taken by producers during their production planning. On other hand, I think that this economic fact is enhanced by financial constraints, because the lack of credit in presence of higher cost and even higher increased prices, limited the possibilities of investment to respond positively to higher prices; particularly in Mexico, we haven't a Banrural anymore.

In Mexico the agricultural producers face unfavorable circumstances even though the spot prices in international markets are higher because its costs have grown too. In June urea, one of the principal fertilizers, climbed 46% annually. The volatility of corn prices rose, affecting prices expectations; for example the coefficient of variation of corn price rose to 0.11 from 0.05 in the first semester of 2008 against the first semester of 2007 in international markets, twice in its degree of volatility. And in the last productive cycle, the average salary of agricultural workers registered in IMSS rose 8.3%. These circumstances; higher prices of fertilizers, higher labor costs, and volatile prices, make that at least in the supply in Mexico would not rise at the same rate as higher prices did. In fact, in corn market of Mexico the corn area planted this summer is not considerably higher than other cycles even with high prices; the area planted this summer is 16% below its decade record in 2004.

Under this approach we could conclude that spot prices are result of changes in fundamentals factors in agricultural markets. However, a link between future markets and agricultural prices would be possible given the long run relationship between prices and production costs. If oil prices is the principal cause of high inflation in the world, because it is causing high labor costs (trough inflation expectations) and higher prices in fertilizer and other agro-chemicals (given they are derivates of oil and gas), then oil price above its fundamental caused by speculation is affecting the prices by this channel: a byproduct of the bubble in the oil market. But affirm it definitely requires tested if the presence of this transmission channel is real, beginning with find if the current price of oil is above its fundamental, inflated by excessive speculation.