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Ed Lotterman: Cattle price yoyos are a familiar cycle

Ed Lotterman: Real World Economics
Ed Lotterman: Real World Economics Staff

Falling stock markets are getting the headlines, but U.S. cattle producers face even sharper and much more real-world declines.

At the end of 2015, farm prices for fat cattle were down nearly a fourth from highs reached a year earlier. This is bad news for producers, particularly those with cow-calf operations rather than feedlots. It is good news, however, for consumers and restaurateurs who will pay less to put steaks, burgers and roasts on the table.

It also is great news for econ profs who have to teach the “cobweb model” of how market prices evolve in economic sectors with long lags in how producers increase or decrease production in response to higher or lower prices. The phenomenon isn’t limited to livestock. The current glut of iron ore and steel results from very similar dynamics, as does a yoyo pattern of salaries of aeronautical engineers.

But the “cattle cycle” is well-established as an example of the phenomenon because it is particularly accentuated.

As for steel, iron ore, oil, soybeans and other primary commodities, the current slump in wholesale beef prices follows a sustained period of above-trend prices. It’s this multiyear boom in prices that was the anomaly, not the current drop, which is a return to longer-running trends. But the nature of all these businesses is that when price trends change, suppliers tend to overshoot on both the up and down sides.

If one looks at what economists call “current” prices — that is, without any adjustment for inflation in the general price level — then beef prices have been going up for 20 years, with particularly sharp rises in the past five. But adjusting by the consumer price index gives a different story. By this measure, over recent decades, beef prices have increased less than the general price level. After the wild fluctuations of the 1970s, the general trend was downward over the quarter-century ended in 2009, from generally around $1.40 a pound to producers in 2016 dollars back in the mid-1980s to around $1 per pound 25 years later.

Of course, there were significant short-term fluctuations around those trends. And at the end of 2009, prices began a five-year upward run that topped out at around $1.70 by the end of 2014.

Since then, they have fallen by a fourth. That brings them about half-way back to where they were when the wild ride began. In relative terms, the drop from the high is not yet nearly as drastic as for crude oil or iron ore, nor, indeed for crops like wheat, corn or soybeans. But beef prices still may be far from their bottom.

The key to all of this is suppliers’ delay in raising production in response to higher prices. When intro econ students learn how equilibrium output rises in response to higher prices, the reaction is assumed to be immediate. In the real-life cattle sector, that is the case, and cannot be.

To increase beef output, more calves must be born. To achieve that, the total number of stock cows must rise. This means young females that might otherwise go to slaughter have to be held back.

In well-managed dairy operations, cows can be bred to have their first calves at 24 months of age. But in beef operations, where climate often governs the optimal calving season and nutrition of herd replacements is less manageable, three years of age is most common. So producers must wait three years after prices go up to get more calves on the market. In the meantime, holding females off the market reduces beef supplies, accentuating uptrends in prices and motivating still more holding back of replacements. It is a self-amplifying process.

When successive cohorts of young cows start popping out calves and these new calves reach market weight, slaughter numbers rise rapidly. Prices fall.

Demand for beef, as for many foods, is “inelastic.” That means even a small increase in supply results in a proportionately large drop in price. So the delayed surge of new fat cattle onto the market can cause steep market-price drops quite rapidly.

Producers respond by culling their oldest cows and holding back fewer young females as replacements. Herds shrink, but the supply of beef does not shrink quickly. Indeed, for a year or two, it may continue to increase.

Just as the holding back of replacements to grow herd numbers contributes to a price overshoot on the upside, the culling and selling of possible replacements needed for net reductions in herd size fosters an often greater overshooting on the down side. The result are yoyo-patterned price- and herd-size cycles of around seven years.

Cycles for hiring newly minted aeronautical engineers differ from slaughter livestock in that there is no holding back of replacements nor culling, at least per se, of old producers with few teeth left in their mouths. But some of the dynamics are the same.

In this field, there were historical “exogenous shocks” such as increased government purchases of aircraft during the Korean and Vietnam wars or the Apollo space program. But it takes four years to get a degree, just as it takes three years for a heifer to have her first calf.

Once new engineering grads begin to spew from university spigots four years after the initial boom, salaries stagnate. Hiring bonuses disappear, and new graduates find it harder to get a job. Eventually, old timers retire, and hiring picks up. Perhaps there is another external shock. And the cycle begins again.

In iron and steel, high prices motivate new mining. New mines take huge capital investments and years to build. Once a new set is opened, supply burgeons and prices fall, but the marginal costs of operating new or old mines are low and output falls little.

So why don’t beef producers, mining companies and aspiring engineers have the foresight not to get caught up in the cycle? The answer is that for any single individual among tens of thousands, the belief that one will be able to get through the door ahead of the rest seems strong.

All indications are that beef prices will continue to fall and remain low for another two years. Feedlots that fatten cattle have lower corn prices, a shorter production cycle and can hedge their risk on feeders they buy, fat cattle they sell and their major feed ingredients. So their problems are less harsh than for cow-calf operators.

It will be a rough couple of years, but most know this is part of the business, and they will survive.

St. Paul economist and writer Edward Lotterman can be reached at boise@edlotterman.com.

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