When talking about farm policy, it's important to understand that in times of exploding demand, the current farm program will work, any farm program will work, and no farm program at all will work, says Harwood Shaffer of the University of Tennessee Agricultural Policy Analysis Center.

“The key questions are, will current conditions continue, and are high prices the future for production agriculture?” said Shaffer, speaking at the recent Southern Agricultural Outlook Conference in Atlanta.

“Particularly, we need to look at the explosion in demand for corn for ethanol in the near-term policy context,” says Shaffer. “We're talking about tight crop markets for many crops, and we're really in unchartered territory. Looking at the traditional stocks-to-use ratio, the markets like to keep corn at between 10 and 20 percent. When USDA came out with their baseline in February, they had us running for 10 years at about 5 percent, and we had a hard time believing that's what would really happen. It seemed very unrealistic.

“Each time in the past, when we've gotten down into that territory, markets have responded. Things have turned around very quickly and we moved out of that 4 to 8-percent territory.”

The corn market, he says, is undeniably tight. “With the ethanol market, corn has taken acres from beans, so beans are somewhat tighter, or tighter than they otherwise would have been in the United States. And the wheat market is tight particularly because there have been some crop problems in the rest of the world, and the availability of feed wheat is low, which has increased the pressure for corn as a feed grain,” says Shaffer.

It's obvious, he adds, that there is furious competition for acres. “The questions are which crop will win out, how will corn maintain its acres, how are beans going to gain more acres, and what will happen with the wheat crop? We have high prices for all of these crops.”

With high prices and tight supplies, there's also an increased risk of production shortfalls, notes the economist.

“If we look at the USDA baseline, we have had strings of years when the carryout stocks were projected to be 6 percent below utilization instead of the typical 10 to 20 percent. In five of the past 10 years, we have seen a production shortfall of 300 million bushels from the previous year. Obviously, our production this year exceeded the baseline. But if you have tight supplies and a 300-million bushel shortfall, they begin to put a tight bind on the market. If we're down at about 5 percent and we lose 300 million bushels, we could end up with $6 or more per bushel for corn,” says Shaffer.

Looking at the long-term policy context, he says, it's important to remember that production will respond to price signals, and that U.S. farmers are not the only farmers in the world who see those prices.

“We hear talk about yield gains in corn and soybeans, and we hear people talking about the fact the average corn yield in the United States could exceed 200 bushels per acre — there's even talk of 300-bushel-per-acre corn. We once thought that 110 bushels per acre was an outlandish notion.

“We have acreage in Argentina, Brazil and other countries around the world with savannah land that could bring in large amounts of cropland. Brazil could bring in 300 million acres of production — more than the total U.S. cropland. That hangs over the market whenever we talk about policy. Our greatest longer-term risk, at least price-wise, is in terms of acreage and yield. These will be increasing not just in the United States but worldwide. American farmers once were the only ones with access to new technology. But it is now available to most farmers anywhere in the world,” he says.

If $6 corn is realized, then acreage shifts will occur in the short-run, says Shaffer. And in the longer-run, there will be investments that increase acreage and yields. “High prices will bring more resources into production. With $3 to $4 corn, the same thing will happen at a somewhat slower rate. We like to think that $3.50 corn will stay here forever, but there's a significant downside risk that it might not happen and we might see $1.85 corn again.”

Looking at the international corn supply, Shaffer says Mexico is talking about a 400-million-acre increase in its corn production. “Argentina is talking about a 20-percent shift from soybeans into corn. Brazil is talking about 230 million bushels of additional corn in its second crop, and 80 million bushels are to be exported. We could see up to 150 million bushels exported. We also see an increase in acreage in Canada.

“When it comes to exports, there could be a decreased need for corn going from the United States to other countries. Production will respond to price signals. We have the yield gain and acreage. The issue we need to focus on is that we have a significant possibility that chronic over-production will return.

“If we bring in large amounts of land for this short-term high price, it will take a long time to wring out that excess acreage. Acreage can come in quickly, but it generally goes out extremely, painfully and slowly,” he says.

Agriculture is different from other economic sectors, says Shaffer. “On the demand side, when we have lower food prices, people don't go from eating three to four meals per day to take up the excess supply. The aggregate intake of food remains relatively stable over very long periods of time.

“Agriculture also is different from other economic sectors on the supply side. With low crop prices, farmers continue to plant all their acres. Farmers plant because they're hoping other farmers 100 miles away will have a drought — they have to plant on that basis. If that drought occurs and they didn't plant, then they have nothing to sell. The only way to participate in the market is to plant.”

Farmers don't and can't afford to reduce their applications of fertilizer and other yield-determining inputs, he says. “They're going to put those on because once they've made a commitment, as long as they can cover the extra cost with extra production, they will put it on.”

With low crop prices, some resources exit agriculture, says Shaffer. The resource that may exit is farmers, but the determinant resource that doesn't change is land — it doesn't exit the market. New producers might take over the land and increase production on the land, but the land usually stays in as a resource.”

A chronic problem in agriculture, he says, is that technology typically expands output faster than population and exports expand demand. And much of that technology is paid for by U.S. taxpayers.

“The common economic formula is that low prices cure low prices. Consumers should buy more, producers should produce less, equilibrium will return, prices will recover, and the problem is solved. But in agriculture, lower prices don't solve the problem. You have little self correction on the demand side and little self correction on the supply side.”