The News & What it Means: A Government Payment Becomes a Missed Market Signal

By John DePutter & Dave Milne – August 28, 2018

 

The news:

“The Trump administration will spend up to $6.2 billion this fall to shield crop and livestock producers from retaliatory tariffs imposed by China and other trading partners, said Agriculture Secretary Sonny Perdue on Monday.”

– Agriculture.com, Aug. 27, 2018

 

What it means:

In a nutshell, direct payments like this confuse and obstruct market signals that might otherwise tell producers to plant more, or less, of a certain crop.

 

In this case, the White House said it plans to compensate American soybean growers to the tune of $1.65 per bu or about $3.6 billion in total for any market injury caused by the government’s trade dust up with China.

 

Since soybean futures have fallen about $2 per bu since earlier in the year when the trade issue first started to surface, the planned government payout might seem like reasonable compensation. However, it’s important to remember that a good portion of the losses in the soybean market can also rightly be attributed to the likelihood of a record-large American crop this year. At $1.65 per bushel, the soybean subsidy stands out against the rest – the payment for corn is a meagre one cent per bushel and wheat is 14 cents per bushel.

 

So, when governments start artificially pumping up returns for a certain crop, there’s little or no incentive for farmers to heed the natural call of the market to adjust production accordingly. US and global soybean supplies have been building for a number of years – culminating with what can only be described as a glut for 2018-19.

 

During those years when supplies were building, demand was hot and prices strong, encouraging farmers to produce ever more. But eventually, as supplies start to match or exceed demand, prices fall and the market functions as it should to tell farmers to tap the brakes on production.

 

With soybean prices where they are now, the market would be clearly telling farmers to cut back in 2019-20. However, with cheques arriving in the mailbox courtesy the government, farmers might simply go ahead and plant the same amount of soybeans – or even more – at a time when they should be cutting back.

 

The result is a potentially skewed market in which already heavy supplies are overburdened even further.

 

The government’s cheques won’t last forever. And when they stop arriving in the mailbox, farmers will discover they’ve overproduced to the point it may take an extra-long period to clear the glut and allow prices to work higher again. The situation is doubly worse for farmers in other parts of the world, such as Canada, where the US futures price is the benchmark, and where they are not getting the same government payouts.