The last major drought in the Corn Belt was in 1988. For the next 22 years there were no significant droughts. It had been so long that many professionals in agribusiness had no memory of a drought. Then, in June, under blistering temperatures, the yield of the U.S. corn crop started to melt away. A full-scale drought developed that is a rival to 1988. Instead of the 15 billion bushels of corn that seemed possible earlier this year only 10 billion may, in the end, be produced. This is a mean and ugly drought that will cause hardship to uninsured crop farmers as well as all animal industries worldwide that rely on grain not to mention the millions of people that will go hungry.
It should be no surprise that the Corn Belt was visited by a drought, the surprise was that it took so long. Between 1970 and 1988 there were four major droughts and then there were no serious droughts between 1989 and 2011. The chance of a drought in the Corn Belt any given year is approximately the same as coming up with seven when rolling two dice, 17 percent. The dice were rolled 22 times between 1989 and 2011 and never once did seven show up. In Vegas they would have suspected the dice were loaded.
The analogy with dice is, of course, not completely accurate. Although there is a 17 percent historical probability that a randomly chosen year will have a drought in the Midwest, they do not occur randomly. There are periods of increased risk followed by periods of decreased risk. The challenge is to correctly identify the cycle to be able to make accurate predictions.
Identifying drought cycles
People have been trying to identify the cycle for as long as there has been agriculture in the Midwest. The Benner cycle developed in the 19th century from, of all things, the price of pig iron, seems to fit some of the drought data. The 20th century saw the intense study of El Niño. There is a correlation between the cold phase of El Niño Southern Oscillation and droughts but then there is the problem of predicting El Niño Southern Oscillation.
Although the ability to predict the cycle is still imperfect, the important point is that there are periods when drought is more common and periods when it is less common. After 22 years without a major drought, the Midwest may well be entering into a period of more frequent droughts.
Stretch of drought-less years over
In the graph of U.S. corn yield from 1970 to 2012, the long golden era between 1989 and 2011 is clearly shown. Yields shot upward, the weather was kind and billions of bushels of corn were lavished on ethanol production. The U.S. was asleep at the wheel during the last 22 years, lost in a dream. Now there has been a rude awakening to reality as the car veered off the road and smashed into a tree.
The reality is that 1) droughts happen, 2) extra supplies of grain need to be stored to cover the possibility of a drought and 3) the mandated use of corn for ethanol can be too rigid.
The recent golden age of near perfect weather is over, and if it ever returns it may be decades from now. Even without considering the possible effects of global warming, just the historical record, the Midwest is likely to be entering into a period of more frequent droughts.
Storage must happen
At the time of the last drought the ending inventory of corn was equal to 20 percent of annual use. Since then, the average inventory has dropped to 10 percent. Every thoughtful publication from the Bible forward warns about the danger of not having enough grain reserves. Unfortunately, in a just-in-time economy nobody wants to pay for storage of grain just in case. Although free-market solutions are normally more efficient, there may be a legitimate and necessary role for government in subsidizing the storage of grain. One possible solution, subsidize the purchase of bins. With cheap bins farmers will naturally store more grain in years of low priced corn and sell more corn in years of high priced corn.
Smarter ethanol production policy needed
Back in 1988, very little corn was transformed into ethanol (gasohol back then). Now, the net effect of ethanol is to take possession of 33 percent of the current harvest. While corn use for ethanol is mandated by the government other grains users are left to fight over the shrinking remainder of the crop. A smart ethanol policy would find a way to decrease ethanol production in a time of drought and not rigidly continue production no matter what the consequences.
So what should be done? There are obviously many different possible solutions. One possible solution is a free market in ethanol. The ethanol industry says that eliminating the mandate will not affect the use of corn. OK, if it makes no difference then there is no reason to continue the mandate or any other government interference in the ethanol market. Move to a free market but provide ethanol producers the same bin subsidy offered to grain producers. With enough bins the ethanol industry will store more corn in the good years and empty the bins in a drought.
Conceptually, it is quite simple to lean against the worst effects of drought; store more grain and adjust the use of ethanol to fit the reality of grain supply. The devil is, of course, in the political details.