Some bubbles will give you a headache when consumed. Some bubbles will leave your face a pink, sticky mess when they burst. And some bubbles that burst can leave you with both a headache and mess, particularly if your marketing plan was anchored to it. Is your marketing plan on the bubble?

It is not a case of if, but when, the bubble bursts suggests Iowa State economist Bruce Babcock in the winter issue of the Iowa Ag Review. He says high prices are their own worst enemy because more profits invite more competition and more production. That means lower prices. Babcock says we may have high corn prices now, but in the past 50 years there have only been two occasions when corn prices were high in successive years. Short global crops did the trick in 1973-75, and from 1979 to 1984 prices were kept up with drought and farm policy.

In the mid-1990’s corn futures were in the upper $3 range, then began a five year slide, including a drop in demand cause by the Asian financial crisis. Today, a record corn crop has been followed by record high prices, even while a short soybean crop has been followed by record high prices. Unlike the 90’s, the markets are indicating these prices are not temporary, because 2009 and 2010 futures offer similar prices.

But if these prices are permanent, Babcock says, “The impacts on agriculture would be staggering…” Land rents should increase by a factor of 2.8, land prices should increase, and higher production costs follow. He says the cost of raising hogs, finishing cattle and producing milk and eggs rise dramatically. Those costs are passed on to consumers, but so will higher costs of specialty crops and vegetables, which are displaced by corn and soybean acreage. Babcock rhetorically asks, “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?”

The Iowa State economist points to the recently enacted federal energy policy that amplified the use of corn and soybeans for biofuel production, and says that came at a time when supplies of grains are already tight, telling the markets to encourage world production. He says the US can only expand with the help of good growing weather and some shift of the CRP back into production. South America can slightly increase production acreage. The Ukraine may not have the infrastructure to increase much. The EU will expand pursuant to its own bio-fuels policy. And such a slow response to a call for more production is one reason for high futures prices the next two years.

But Babcock says over time production will increase as a result of the current profit signals which cannot be sustained for the long term. However, he believes the world’s demand for bio-fuels will require more production that may be high cost and require lower yielding acreage. And that he says may keep future prices at a higher level.

Babcock analyzed a variety of scenarios involving corn prices, petroleum prices and the retention and elimination of ethanol subsidies and import tariffs. Those policies help ethanol producers pay higher prices for corn; but a loss of those implies lower corn prices in the wake of high production costs.

Summary:
High grain prices have resulted from a strong demand for grain as well as acreage to produce other crops. Unlike prior times of high prices, the futures market indicates several years of sustainability. However, current values indicate land prices and rents should be higher along with production costs. Today’s strong prices result from the demand on grain to produce both food and bio-fuels, the latter of which is helped by protective policies. The loss of those policies would result in lower grain prices, but land prices and production costs might remain.