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Political policy, a source of price, cost and profit variability

Political decisions in the form of new laws, regulations, permitting requirements, etc. are extra-market forces which can cause market costs and revenues to swing significantly from the pathway set down by fundamental forces, like supply and demand.

Thursday 17 October 2013 (4 years 8 months 4 days ago)

We pointed out last time that it can be very useful to begin to view the world as a set of distributions rather than as points in time. The reason for this is that nearly everything we experience over time is variable and by understanding variability, we can assign probabilities to possible outcomes. Once probabilities are assigned, better decisions can be taken to manage risk, enhance profitability and gain access to capital. Nowhere is that more evident than in natural and biological processes such as agricultural production.

We have come to rely on the mean value of important costs, prices, test results and metrics to simplify our lives so that decisions can be readily taken. While this approach is useful from time-to-time, make no mistake about it, we conceal insight to significant profit opportunities when we trade the information-packed distribution for the convenience of its mean value. In addition, if we blind ourselves to production and financial variance, we eliminate one of the most effective early warning systems for financial trouble at an early stage when it can most effectively be addressed.

There are many sources of variance in agricultural production and profitability. Since the world seems caught up in the political showdown occurring in the United States over the budget we can take advantage of the awareness to highlight one of the sources of price and cost variability (and therefore profit variance), namely, political policy.

Political decisions in the form of new laws, regulations, permitting requirements, decisions to slow or speed discretionary approvals or inspections, etc. are extra-market forces which can cause market costs and revenues to swing significantly from the pathway set down by fundamental forces, like supply and demand. We live in an age where the acquisition and maintenance of political power trumps almost every other consideration, including common sense, statesmanship and the common good. A textbook case is on display in the current budget battles in the United States.

Many are wondering what would be the economic impact of a default by the United States on its debt obligations coming due at mid-month. The key thing to understand is whatever happens in the next few days; purely political calculations and not economics, finance or so-called budgeting is at the root of it. President Clinton, commenting on the current situation is quoted as saying “Constant conflict is actually often good politics, because the more you can inflame your supporters, the more likely they are to show up at Election Day”.

Rest assured, the United States is fully capable of paying the interest on its debt obligations without raising the debt level and will certainly do so once one of the parties believe their political capital has been maximized. In addition, the US is also fully capable of making the partial “shut down” of the government underway already essentially invisible in terms of impact on the vast majority of citizens and commerce. The level of discretionary inconvenience, market turmoil, targeted “punishment” and lost opportunity for certain citizens and businesses is created to advance anticipated political gain.

Paraphrasing President Clinton once more regarding whether or not President Obama should take action to stop the partial shutdown, he said, “I guess [Obama] could stop it, but the price of stopping it is higher than the benefit of letting the opposing party take the blame for the consequences of it.” The White House then set about making sure the consequences were not minimal.

In the agricultural arena, this has meant closing the USDA.gov web portal and ceasing to report most market news including daily market prices, quantities sold/purchased and quality distributions traded. In addition, the government is postponing major weekly and monthly situation reports and warning that the flow of information should not be expected to begin immediately after reopening as it is a federal crime for government workers to maintain most of this when they are furloughed so it cannot be instantly turned back on.

Access to other government informational websites for agriculture as well as access to key historical databases has been temporarily curtailed. This causes problems since reference to prices in market news reports are often written into multi-year sales agreements and relied upon in formula pricing as well as purchasing decisions. Accurate and timely price reporting forms the basis of competitive markets. Not only is government price reporting critical to most payment schemes between producers and processors, in a broad sense, it guides the flow of products from lower value to higher value ends. This is especially true for perishable products.

Larger agricultural entities have built or gained access to information networks that are frequently superior to government information anyway so those left in the dark are most often family farms and small agricultural businesses who are likely to be very vocal.

Workarounds in pricing formulas so animals could be sold without referencing the traditional government price reports were quickly put in place by buyers and sellers to allow trading to continue. This is less than ideal but suitable for the short run. It could however, lead to market distortions, like under or over production if days drag into weeks or months.

Since government inspection has become ubiquitous in the United States, slowing the pace of inspections significantly slows trading within the United States and abroad. Most commodities require grading, inspecting or verification, most of which is conducted by the government, though in many cases state governments perform some of these functions. Exports have been slowed substantially so opportunities are being missed and prices should be negatively affected for U.S. producers in the short term. Luckily, much of what is shipped overseas gets approvals and inspections up to 30 days prior to actual departure so if the shutdown is relatively short, the preapprovals can fill the gap.

Next time we will demonstrate how accounting for variation in prices and costs can enhance your ability to understand your business, target action plans to specific problem areas and communicate the level of risk you are assuming both to your partners and to outsiders like investors or lenders who have a stake in your profit performance.

October 16, 2013

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