What's that got to do with the price of eggs?

Posted Wednesday, April 27, 2011 in Analysis

What's that got to do with the price of eggs?

Why commodities prices are going up, and what that means for the bottom lines of households.

analysis by Gina Hamilton

You just filled your gas tank and practically fainted, right? What's it up to now? Fifty dollars for an ordinary family car? It was $23 last September. Or you bought just a few things at the supermarket -- milk, bread, a little fruit, some cold cuts and a small package of cheese -- and spent $24. It used to be $13 for the same stuff less than a year ago ... Or you bought just 100 gallons of oil (and are counting your pennies to do that) to tide you over because of the sticker shock when you asked what it would cost to fill your 300-gallon tank.

Food and petroleum products aren't alone. All commodity prices -- including metals, such as gold and copper and silver -- are going up, too. And health-care increases outpace even commodities.

All this in an economy where the Fed chair is worried about DEflation, and where our parents are asked to forgo a cost-of-living adjustment to their Social Security because the inflation rate (for everything excluding food and fuel!) is among the lowest rates since the Great Depression. Last fall, the inflation rate was indeed quite low, only 0.1% in September. Now, it's at a more moderate 2.7%, still incredibly low by economic standards.

So why on earth does it feel like you are losing ground?

Well, because you are.

The prices of everything aren't really going up, it's just that the prices of things that ordinary human beings purchase are going up. Because ordinary people -- at the pump, at the supermarket, at the hardware store and at the jewelry store -- are dealing with commodities.

Commodities are goods for which there is typically a reliable demand, but the supply might fluctuate somewhat from time to time. They are considered to have similar quality for finance purposes. For instance, consider spring wheat. As far as traders are concerned, spring wheat is spring wheat, whether it is grown on an organic farm, harvested when the grain is sprouted, or whether it is raised near toxic chemicals. Consumers might see and be willing to pay more (or less!) for such a difference, but traders do not take such things into account (which is why organic farmers have less ability to compete on a commodity-wide scale). While people continue to eat bread, and bakeries have a steadyish demand for wheat, the price of bread falls and rises depending on the supply available -- usually.

Early in the growing season, commodities traders do a bit of gambling. They decide whether they think it's going to be a bumper crop, which will cause prices to be low when it comes time to sell (although there will be a large supply) or whether there is likely to be a drought or a deluge that year, which will drive prices higher (although supply will be low). The traders will ironically do better if the supply is on the low side; consumers should do better if the supply is high. By locking in the price they will pay, the traders then pay farmers, who can purchase seed and fertilizer and hire people to work in the fields. At the end of the day, whether the farmers produce a little or a lot, they will have already gotten their share.

The amount of wheat can be affected by many things between seed time and harvest. Weather, insects and so forth can play a role. So this type of commodity is known as a futures commodity; that is, a guess is made early on that conditions will favor the growing of wheat throughout the growing season, and will be worth it to the traders to finance the growing season.

The traders never really take possession of the wheat or any other commodity they have on their hands ... by the time the commodity is harvested, they have sold their share in the thing to middlemen who trade with the bakeries and flour mills and so forth. By gambling on the farmers, the traders made a little money ... or lost a little money ... on the harvest.

The price of bread should reflect the law of supply and demand. When supply is great, price goes down, and when supply is low, price goes up. Back when we bought our wheat from farmers, or at least a flour mill directly, that is how it worked. But as anyone who has bought a loaf lately can tell you, that's not how it works anymore.

In the case of food commodities, there has been a bit of monkeying around with prices since the Great Depression. The rationale then was to keep farmers on the land, and the way to do that was to offer some kind of price supports -- or to pay some farmers to leave their land unplanted -- in order to keep the price of wheat artificially higher than it would otherwise be. In Maine, this is most obvious in dairy products, which are consistently higher than they are in many other parts of the country, thanks to dairy price supports. However, in most cases, these price supports no longer benefit the small farmer, as they do in Maine, where we do not have large agribusiness. Instead, they support factory farms and futures traders, who can rely on higher prices, despite growing conditions and supply.

Oil, as a commodity, also has some sort of price supports. Much of the world's oil is produced by members of the Organization of Petroleum Exporting Countries, or OPEC. OPEC members work together to increase or decrease supply to keep the price stable, in theory, but often OPEC behaves with a political motive of sorts as well. Crude oil was trading this week at around $123 per barrel; gasoline prices could reach $5 per gallon, according to a Shell Oil executive, within a year.

Oil is traded in U.S. dollars, and so occasionally, thanks to devaluation done to the dollar to create stimulus, we inadvertently raise the price of oil ourselves. When the dollar is high, the price of oil is relatively lower; the reverse is also true. Falling dollar values raise the cost of oil to U.S. consumers.

Because oil is often produced in hazard zones, such as Libya, that also causes its price to rise. Across the Arab world, as uprisings occurred this spring, oil or oil transport was put in peril. To an extent, what we are seeing at the pump and hearing over the phone from our oil dealers has something to do with that.

But not enough. The price of a gallon of gas is currently $3.87 in Maine, a full $1.41 more than it was last year at this time, a rise of 36.4 percent. Oil prices aren't rising quite that dramatically. On April 27 last year, Brent crude was trading at $87 per barrel. Today, it is $123 per barrel -- a rise of 29.3 percent. Output is roughly similar. What -- or who -- is taking in the margin? Who is getting that extra 7 percent that we are paying at the pump?

Welcome to the nasty world of oil speculation. People who purchase oil futures when they are low and sell when they are high have always been around, but more people are engaging in this kind of behavior now, and are holding shares just a little longer to force prices up.

But in the case of oil, supply and demand does play a greater role. As developing nations start competing for oil, the costs rise for everyone.

Metals are also based on supply and demand, and in those cases, commodities traders are driving the prices of gold and copper and other metals up by the sheer demand for these, not only in traditional uses such as plumbing and jewelry, but also in technology, where gold, copper, silver and other metals are used, but rarely recycled into new products. In short, computers and other high-tech gadgets are taking metals out of the system and not returning it. The demand is rising, but the high cost of recycling, and the high human toll of mining, keeps the supply low. Metals are also traded in U.S. dollars, which is also causing prices to rise for consumers who are buying in dollars.

As the developing world comes on line in a dozen ways, we can expect the prices of commodities to rise meteorically, especially for goods that are finite, like metals and petroleum. But it is time to revisit the idea of supporting large factory farms with government subsidies for food-based commodities. The prices should be high enough to provide a good return on their investments now without taxpayer support. If a way can be found to subsidize local family farms while allowing large agribusiness to stand on its own, this would be one good way to trim some fat from the federal budget.

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