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Connecting 'stagflation' with a commodity price boom

In today's USA Today, 'stagflation' was the buzzword discussed
in the US financial circles, with the last real period of stagflation
mentioned in the 1970's.

Mostly this period occurred in the mid-to-late
70's, after commodities had all hit their peaks in 1973 (soybeans) and 1974
(corn and wheat). Oil had also already made its run by the time
'stagflation' became a popular term.

In fact, this current commodity boom has played out eerily similar to the
1970's, with first a boom in oil prices followed by a boom in grains. This
took a few years to play out, as by 1974 both energies and grains had seen
most of their bullish run. Then gold and silver took center stage in the
70's, so one potential difference so far is that gold has already run to new
all-time highs (about the same time as soybeans broke above their all time
highs in early January).

However, both gold and silver were behind the
grain/energy commodities in their 1970's bull run - so far not so during the
2007/08 run.

While this current boom period doesn't have to be exactly like the 1970's,
there are some notes worth highlighting about the 1970's boom as compared to
the late 2000's. First, the 1970's was a period where the US hit its peak
oil production, and the worry was that we couldn't produce enough oil to
meet demand, and the world as we knew it was expected to change because of
the 'oil crisis'. But we turned to oil imports in the US to meet our
expanding demand, and that has been the case until today.

Today, the 'peak oil' production for the world is supposed to have been hit,
and now the world is supposed to find alternative energy sources to power
what is a highly dependent oil/energy world. We are increasingly becoming
addicted to cheap oil, with it feeding the industrial economies of the
world.

Now we are turning our attention to alternative fuels, and it might
be the job of the market to make these alternative energies more economical
as well as to force people to change their living habits, lessening their
use of energy worldwide. Price is a powerful force to make changes, and
today that seems to be the charge of the marketplace. So oil went up first,
making ethanol the boom stock of 2006-2007.

While oil was first on the list, second has been the grains, with increasing
use of grains to produce energy making shortages of grains. This has put
pressure on production so keep up with expanded demand, and now with
increasing world demand for food (driven by rising Chinese and Indian
incomes - one third of world population!), there is a crunch to make sure
the world can produce enough to meet all these new sources of grain demand.
So food prices are going higher, starting with corn in fall 2006, spreading
to wheat and soybeans in 2007 and continuing into 2008.

Rather than the Russians coming in and supplying the shock to world markets
like in the 70's, it's the index funds who are buying US grains in the late
2000's boom, currently owning 3 billion bushels of corn, 1.5 billion
soybeans, and 1.4 billion wheat bushels (and still buying at $5 corn, $13
soybeans, and $10 wheat). They are the power behind this mammoth 17 month
long bull market (and still going) instead of a foreign source (like Russia
in the 70's).

While grain prices hit their peak about 24 months after the boom started in
the 70's (by Dec 1974, all grain markets peaked for about the next 2
decades), it still isn't certain how long the late 2000's boom will last.
In the 70's, after grain prices topped we never did drop back below $2.50
wheat, $5 soybeans, or $2 corn except for rare depressed moments (like when
we unloaded LDP grain).

In fact, prices stayed in a new range and at a new
plateau for at least 6-7 years while agriculture boomed. Profits accrued to
producers into the 1980's, and once we had geared up production "from
fence row to fence row" then we oversupplied the market and our great 'Ag
Crises' of the 1980's was on. Land prices peaked a full 7 years after grain
prices in 1981, at price levels about 2-3 times their 1974 levels (when
grain prices were at their peak).

Inflation became the norm by the mid-70's, with increasing inflation rates
until we broke double digit levels by the late 70's, and even approached 15%
yearly inflation rates in the general economy (not just ag). By the late
70's, the common wage earner in the city was asking for wage increases to
keep up with inflation, and the snowball kept getting bigger as inflation
expectations crept into the economy in every corner of the country. Stock
market companies were being killed by higher wages, commodities, and
shrinking profit margins during 'stagflation', the combination of inflation
and a stagnant economy.

Paul Volker, the FED chief, stepped in and slowly
squeezed these inflation expectations out of the economy but at great cost.
Left in the scrap pile of business failures by 1987 (the bottom of land
markets) was lots of farms, businesses, and people who got used to operating
on borrowed money in the 70's - only to be gobbled up by this strategy once
Volker made the commitment to squeeze inflation out. From 1981 to 1987
Volker did just that, but it took 20%+ interest rates and a declining land
market in agriculture. Real interest rates (bank rates minus inflation)
approached all time highs around 8% or more for a number of years, and that
just about killed anyone operating on borrowed money.

Will we repeat these same events as in the 1970's? A lot depends on the
players involved, mostly policymakers in the US and world. How will current
Federal Reserve chief Ben Bernanke respond? Congress? The President
(whomever that is) over the next 8 years? Will interest rates and inflation
follow the 1970's trend? Will land values continue to boom the next 7 years
like the 1970's? How will the average US worker respond if inflation takes
off? What about the impact of globalization (China and India booming
economies)?

Stay tuned, as the current commodity boom in energy and grain
prices and sagging US dollar might be the beginning of a whole new saga.
How it plays out might end up affecting virtually every business and person
in America, and perhaps the world!

The information contained, while not guaranteed as to accuracy or
completeness, has been obtained from sources we believe to be
reliable. The opinions and recommendations contained are based on
our judgment and do not guarantee that profits will be achieved
or that losses will not be incurred. Recommendations should not
be construed as an offer to buy or sell commodities. There is
substantial risk of loss in trading futures and options on
futures.

If you have questions about this column, call Progressive Ag at 1-800-450-
1404, or email ray at rlg@progressiveag.com (return receipt requested).

In today's USA Today, 'stagflation' was the buzzword discussed in the US financial circles, with the last real period of stagflation mentioned in the 1970's.

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