The Real Thing?

"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