Why the U.S. Drought Is a Double-edged Sword for Latin America

Farms across the U.S. Midwest are full of parched earth and wilted crops, signs of the worst drought to hit America's grain-growing region in more than 50 years. Summer has been brutal for the U.S. agriculture industry. A lack of rain has ruined corn, soy and wheat fields. And the outlook looks dim: The U.S. Climate Prediction Center forecasts drought-like conditions for the region through November.

The forecast is brighter on South American farms. Argentina and Brazil, two of the world's largest grain producers, stand to benefit from the U.S. breadbasket's misery. There, high prices are prompting farmers to plant more soy, wheat and corn. "The U.S. drought has created an opportunity for producers. Farmers are planting more here in South America to meet international demand," says Andrés Alcaraz, a representative for the Argentine Center for Cereal Exporters.

That's potentially good news for consumers. Increased production in South America could eventually moderate food prices, which rose by 10% from June to July, partially as a result of the drought, according to the World Bank. Corn and wheat prices went up by 25%, while the cost of soy increased by 17% over that time period, the bank reported.

But before South American farmers can come to the rescue, the spike in food prices poses a potentially disastrous situation for Latin America's consumers, especially the poor. Several countries have become dependent on U.S. grain exports, making them more vulnerable to market volatilities. "The current situation in the United States, with the drought and the decrease in production, is a double-edged sword for Latin America," notes Fernando Soto Baquero, the United Nations Food and Agriculture Organization's (FAO) regional representative, based in Chile. "Grain-producing countries, like Argentina and Brazil will benefit…. But we're very concerned about other countries, such as those in Central America, where the price of food is increasing."

A Global Problem

U.S.farmers were expecting a strong crop back in spring. That was before Mother Nature stopped cooperating. In August, the U.S. Department of Agriculture reported that just over 20% of crops were rated "good to excellent", a significant drop from spring when nearly 80% of crops were rated as such, and from the 66% figure reported in June.

On an international scale, that's important because the U.S. has been one of the world's largest producers of commodities. It's the largest grower of corn, by far, and it remains the largest soy producer, although that could change. U.S. farmers grow roughly one-fourth of the world's wheat exports. And they are a leading producer of sorghum, a grain mainly used for animal feed. When drought hits U.S. farms, the world feels it.

"The situation is very serious right now. We've seen food prices have increased sharply … especially for soybeans and maize, which are right now at all-time highs. Also the price of wheat is very high," says José Cuesta, a senior economist at the World Bank.

Latin American imports of U.S. cereals have already begun falling sharply. From May to June, U.S. exports to the region dropped by 35%, according to the latest U.S. trade data available. Meanwhile, high prices have prompted a major uptick in production of corn and soybeans in South America, where farmers are planting more than at any point in the past decade, figures from the International Grains Council, which tracks production, show.

Corn yields in the region are forecast to increase by nearly 18% from the 2010-2011 season to 107 million metric tons, led by Brazil and Argentina, which account for 90% of the continent's total. Soy yields are forecast to increase by nearly 5% to 142 million tons, according to the council.

"Farms are responding to international demand and to the high prices on the futures markets for grains," Alcaraz notes. "We are seeing farmers planting more grains than they have for several years." Futures markets are especially high for soybeans, with prices up 26% on U.S. markets from a year ago.

Argentine farmers are planting an estimated 110 million metric tons of grains, of which soy is the largest product. Last year, one in which the country experienced its own drought, farmers only harvested 90 million metric tons, of which 40 million were soy, according to government statistics.

Marcelo Cesar Moscata, director of Exportadora Argentina de Granos, S.A., a small exporter (by international standards) of grains and oils, notes that the situation in the U.S. is lamentable, but provides an opening for other countries. "Obviously, nobody wants a drought in the United States, for those farmers, but we are planting more to make up the difference. So, for us it's a call to plant more," he says. "We've had our own drought, so we know what it feels like. We're glad to be having a good season this year." Moscata says he's expecting a double-digit percentage point bump in income when he sells his next harvest.

In neighboring Brazil, farmers suffered through their own drought this year. In the first quarter, agricultural output, which accounts for 30% of the country's gross domestic product, shrunk by 8.5%. Unlike in the U.S., however, the drought didn't endure. Brazilian farms, led by multinationals, have rebounded. Exports of corn increased by 111% in April-June compared to the previous year. Soy exports are up more modestly, by 11% over the same time period (although that grain is more important to the Brazilian economy).

Bolivian corn production is expected to rise by 4% from 2011 to 1 million metric tons, thanks to good weather and more plantings. Chile and Colombia are also growing more corn — about 8% over 2011 levels. And Mexico's output this year is expected to rise by 14% to 21.8 million tons, according to FAO forecasts.

"The response we're seeing from the major grain-producing countries in the region shows how important they are to the world markets," Soto, of the FAO, notes.

Exports of grains, however, have become a source of contention, at least in Argentina. The region's famous political instability was on display earlier this month when port workers went on strike for three days, disrupting exports from one of Argentina's major shipping channels. The strike was called because health inspectors were demanding higher wages. Meanwhile, the country's government, under policies furthered by President Cristina Fernández de Kirchner, has sought to protect local food prices by putting restrictions on export markets. The government has considered raising the tax on soy exports, for instance, to 40% from the current 35%. It also places limits on the export of wheat and other products. "It's controversial, yes, but depending on who you ask," Alcaraz says. Controls makes sense from the viewpoint of a consumer who fears international volatility will cause bread prices to spike, he adds, but less for a farmer looking to ramp up exports to take advantage of high prices.

Cost Concerns

The cost of bread and other products in countries that don't produce — or export — grains has already been rising. South American farms will begin harvesting soy and corn in February to April of next year (growing seasons are reversed there as compared to the U.S.), leaving a lag of several months before their increased production can bring down prices.

"I don't see food prices moving for six months or more," predicts Timothy Wise, director of the research and policy program at the Global Development and Environment Institute at Tufts University in Massachusetts.

The World Bank and the FAO have both said that the high prices could have deleterious effects on Latin American consumers. "In countries that are not net exporters of gains, consumers remain very vulnerable to price changes," Soto says.

The FAO's overview of Latin America drew a sharp distinction between counties like Brazil and Argentina, which export grains, and poorer countries, which import staples, especially those in Central America. "We are very worried about the situation in countries like Guatemala in Central America or the Caribbean, which have become dependent on U.S. imports, particularly of corn," Soto notes.

Colombia, which imports some 75% of the corn its population consumes, fears the effect of increased prices will be widespread. "The increase affects poultry farming, pork raising and dairy cattle," Raael Mejía, director of Sociedad de Agriculures de Colombia, which represents the country's agriculture industry, told Reuters. "The worst thing is that the prices are going to continue to rise."

In a fruit and vegetable market outside of Santo Domingo, the capital of the Dominican Republic, on a recent weekday, Juliana Alvarez lamented the rising prices of basic food items she relies on to feed her family of four. "Most of the things we use have increased in price. It's a strain," she says while sifting through vegetables as thick rain began to fall on the corrugated metal roof that covered the market stalls.

Nearly a decade ago, hopes were high in countries like the Dominican Republic that a trade pact with the United States would bring stability to markets and cheaper prices to consumers.

Instead, experts say the trade agreement — better known as CAFTA-DR — has made countries more vulnerable to price spikes by subjecting them to the whims of world markets. For instance, imports of U.S. corn to Central American countries and the Dominican Republic — all party to the trade agreement — have spiked in recent years.

Meanwhile, the U.S. has diverted more corn and other grains to the production of biofuels as a result of renewable fuels standards. The U.S. became the top producer of ethanol in 2005 after federal mandates to increase production took place. Those were furthered in 2007 and today, the U.S. produces well above 50% of the total global production of ethanol, a fuel derived from plants, including corn.

The increased ethanol production is partly to blame for the spike in world food prices. A study by Tufts University found that since 2008, between 20% and 40% of the overall increase in food prices in importing countries was due to the U.S. policy to increase production of ethanol.

Increased reliance on U.S. exports at a time when the country has ramped up biofuel production has led to pain for consumer. The price of food has been gradually increasing. According to the Dominican Republic Central Bank, the prices of some products, like soy oil, have increased by 50% in the past three years. Other price increases have been moderate. For Alvarez, the Dominican consumer, "It's not just now — prices have been going up for years."

That might be because this year's jump in prices is one of three that consumers around the world have seen in recent years due to weather phenomenon or policy changes. "I don't look at the price spike of this year as being isolated. I see it as a continuation of what's been happening over the past five years," Wise of Tufts University says.

The now famous 2007-2008 spike in commodities caused widespread controversy in Mexico, where the price of tortillas had shot up. The price increase caused massive demonstrations and led outgoing Mexican President Felipe Calderón to institute a Tortilla Price Stabilization Pact, which capped the price of tortillas at U.S. $8.50 per kilogram (2.2 pounds).

Those remedies were few and far between, however. The Inter-American Development Bank estimates that the 2007-2008 increase in food prices (roughly 20%) pushed 10 million Latin Americans into poverty — the largest increase relative to the size of the population in any region around the world.

"I don't see any countries in Latin America that have put into place any real reforms in the past years to protect" consumers, Wise notes. Another increase occurred in 2010-2011, leading to this year's spike, which Wise characterizes collectively as "One, long continuous increase that continues to test the resiliency of Latin American families. And the longer it goes on the more vulnerable they become."

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