The Real Thing?

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"In
every country it always is and must be the interest of the great
body of the people to buy whatever they want of those who sell
it cheapest."

~
Adam Smith

After
reading Tinah Tran's article on LRC about the Coca-Cola
of her youth
, I couldn't help but be taken back to my own childhood,
remembering how Coca-Cola
played a part of it.

I
thought of hot summer days, sitting on a curb outside the corner
store with my pals. We would each have an ice-cold bottle of Coke,
plan the adventures of the day and razz each other. At the time,
I had no idea that Coca-Cola would indirectly lead me on a path
that would involve lessons in Austrian economics.

Like
Tinah, I enjoyed that sugar-sweet taste of Coca-Cola. Around 1975,
I started to notice a change. The taste I was used to wasn't the
same. I was nine years old, and things like sugar prices, world
markets and high-fructose corn syrup (HFCS) just weren't on my radar
screen. I remember learning about the switch from sugar to HFCS
and wondered why anyone would mess with a great recipe. (This would
happen again in 1985 when Coca-Cola tried to market "New Coke.")

In
the mid-nineties, I moved my family to Arizona for a two-year stint
and quickly discovered the Mexican border town of Nogales. 
On my first trip, I stopped for lunch at a local taco stand and
ordered a couple of tacos and a Coke. When I took my first sip,
my eyes widened and I thought, "This is the best tasting Coke
I've had in a long time." I looked at the bottle and learned
that after carbonated water, sugar was the number-two ingredient.
During my time in Arizona I would make a monthly trek across the
US-Mexico line and “smuggle” back a few cases of Coca-Cola. Upon
moving back to Minnesota, Thunder Bay in Canada became my new source
for the sweet stuff.

But
there is more to the story than cheap, high-fructose corn syrup. 

In
1992, I leased
a seat
at the Minneapolis Grain Exchange for $75 a month and
started to learn about commodities and futures trading. One thing
that always bugged me was the fact that there were two prices for
sugar: the world market price and the U.S. price. The world market
price was nearly always half the price of U.S. domestic sugar. Why
do we have to pay twice the world market price for sugar?

U.S.
vs. World Sugar Pricing

Sugar
is priced two ways in the U.S:

The
first, raw cane sugar, is based on the price of sugar delivered
to New York and is quoted at the NY Board of Trade (NYBOT) as the
Sugar #14 Contract. For the past few years, Sugar #14 has traded
on average between 19.09 cents/lb to 21.42 cents/lb.

The
second, refined beet sugar, does not trade on an exchange. Rather
the price range for wholesale Midwest refined beet sugar is quoted,
FOB factory, each week in Milling and Baking News. Like #14
sugar, beet sugar has traded between an average of 20.80 cents/lb.
in 2000 to an average of 26.21 cents/lb in 2003. (Source: USDA)

World
sugar prices are quoted on the NYBOT as the Sugar #11 (world) Contract,
and on the London International Financial Futures and Options Exchange
(LIFFE) as the #5 Contract. Since 2000, Sugar #11 (raw cane sugar)
has traded at an average price of 8.33 cents/lb. Sugar #5 (refined
beet sugar) has averaged 10.44 cents/lb. (Source: USDA)

As
you can see from the trading ranges, U.S. sugar trades at nearly
twice the world price.

U.S.
Intervention

Since
1982, the United States has supported domestic sugar prices through
loans, the tariff-rate quota system (TRQ) and re-export programs.

The
USDA provides loans at 80% of the loan rate to domestic sugar cane
processors at a rate of 18 cents/lb and to sugar beet processors
at a rate of 22.9 cents/lb for refined sugar. Notice that the loans
are made to processors and not producers (farmers). The reason is
sugar cane and sugar beets are perishable and bulky. They must be
processed into sugar before they can be traded and stored. The processors
agree to pay producers a price in proportion to the value of the
loan received. The USDA has the authority to establish minimum producer
payment amounts.

Another
interesting part of the "loan" is that they are "non-recourse."
Upon maturity, the USDA must accept sugar as payment in full in
lieu of cash repayment of the loan, at the discretion of the processor.
The processor is not required to notify the USDA of the intention
to forfeit the sugar under the loan. The USDA believes that by forfeiting
the sugar, the processor "effectively withdraws sugar from
the market, thereby reducing excess supply and helping to support
the market price of sugar."

The
obvious question is what happens to the forfeited sugar, and how
can this mythical "withdrawal" from the market reduce
excess supply? This is where government really goes to work.

The
USDA has a separate entity called the Commodity Credit Corporation
(CCC). It is government-owned and operated and was created to "stabilize,
support, and protect farm income and prices" and helps maintain
a "balanced and adequate supply of agricultural commodities
and aids in their orderly distribution."

As
an aside, the CCC was incorporated in 1933 under FDR. During the
first year, the CCC along with the Agriculture Adjustment Act (1933),
encouraged farmers to "plow under their abundant crops"
so that farmers could get economic relief!

This
takes the broken window theory to a whole new level. Instead of
the broken window erroneously "creating jobs," relief
recipients were encouraged to throw the rocks themselves!

When
a sugar processor forfeits the sugar to repay the loan, it is converted
(processed) and delivered to the CCC. The USDA is mandated by the
2002 Farm Act to "operate the U.S. sugar loan program at no
cost to the Federal Government" – never mind the consumer. To
discourage forfeiture of non-recourse loans, the sugar price must
be high enough to cover the principal, interest and other costs
at the time of loan repayment. The USDA can accept bids from processors
to get sugar out of CCC inventory in exchange for a reduction in
production.

In
addition to selling back producers' sugar, the CCC is authorized
to sell sugar and other commodities to government agencies, foreign
governments and donate them to relief organizations.

The
tariff-rate quota (TRQ) is another tool the USDA uses to
support U.S. sugar prices. The TRQ bases the tariff on import volume.
A lower tariff is charged on imports within the quota volume. A
higher tariff is charged on imports in excess of the quota volume.
The quota volume is determined yearly by the Secretary of Agriculture.

Finally,
the re-export program "helps U.S. sugar refiners
and manufacturers of products containing sugar, compete in world
markets."

"The
Sugar-Containing Products Re-Export Program is designed to put U.S.
manufacturers of sugar-containing products on a level playing field.
A participant in this program may buy world priced sugar from any
of the refiner participants or their agents for use in products
that will be exported on the world market. This sugar is not included
under the tariff-rate quota for sugar entering the United States."

"The
Refined Sugar Re-Export Program facilitates the use of domestic
refining capacity to export refined sugar into the world market.
This program allows one of three options for refiners. First, it
allows refiners to export domestically produced refined sugar and
later import world raw sugar. Second, it allows refiners to import
world raw sugar for refining and distribution into the domestic
market and later export refined sugar. Third, it allows refiners
to import raw sugar, refine it, and export it into the world market."
(Source: Southern United States Trade Association & USDA)

Conclusion

The
U.S. sugar industry has a sweet deal. No-cost loans and TRQs protect
producers and processors from international competition. The USDA
and the CCC work to ensure sugar industry profitability and at the
same time manage any overstock through governmental sales, sell-backs
to processors and relief donations. In addition, the industry is
allowed to purchase its own commodities at world market prices and
export them at U.S. prices, subsidized by the U.S. government.

Interestingly,
the HFCS industry (corn producers) is all for sugar tariffs and
price support. HFCS is cheaper and easier to transport than sugar.
The greater the gap in price, the more attractive HFCS is to food
producers that purchase sweeteners, as it translates into lower
costs and higher profits.

Henry
Hazlitt in Economics
In One Lesson
, states that one must look "not
merely at the immediate but at the longer effects of any act or
policy" and that economics "consists in tracing the consequences
of that policy not merely for one group but for all groups."

Tariffs
protect the few at the expense of the many. The U.S. government
goes to great lengths to protect the interests of U.S. sugar producers
and processors. The CCC alone has capital stock of $100 million
and the authority to have outstanding borrowings of $30 billion.

Who
is affected by these policies?

First,
the 296,000,000 people who live in the U.S. are negatively affected
as they have to pay inflated prices for sugar and products that
contain sugar, in addition to the federal taxes required to fund
the USDA budget and sugar subsidies.

Second,
the HFCS industry benefits financially from inflated sugar prices
in the form of greater HFCS sales and higher HFCS prices.

Third,
the world's sugar producers and processors are penalized, as they
have to pay duty in order to sell their product in the U.S.

Fourth,
the U.S. sugar producers and processors who are able to get above
market prices for their product at the expense of the U.S. consumers
and world sugar market obviously benefit.

Fifth,
politicians whose campaign budgets are partially funded by the sugar
industry benefit as sugar profits are transferred into political
action campaigns.

And
finally, U.S. Coca-Cola drinkers suffer as they end up having to
accept an inferior product, compared to the same product manufactured
with sugar, both in taste and the possible health issues surrounding
HFCS.

Isn't
it ironic that the same government that spends time investigating
Major League Baseball to eliminate steroid use so players and teams
can compete fairly, creates its own steroids for the U.S. sugar
industry in the form of programs and tariffs so they can "compete
fairly" in world markets?

It
is time for the U.S. government to take the giant log out of its
own eye before it plucks the speck out of another's.

July
4, 2005

Peter
Christensen [send
him email
] is a commercial aircraft parts broker and
does freelance marketing consulting. He lives in Minnesota and loves
hockey, horseracing and fishing.

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