Thursday, December 08, 2022

Real World Economics: The fundamentals of fungibility

We live in a complex, economically interlinked world, but international politics still have major effects on individual households and businesses in most countries.

20150205 Ed Lotterman Sky
Edward Lotterman

This is happening now as trade in grains, oilseeds, energy commodities and non-ferrous metals is physically interdicted by fighting in Ukraine and by resulting economic sanctions against Russia. Such interruptions of normal trade and finance certainly affect households and businesses in European nations near the war, particularly Finland, Poland and Germany. They also affect people in our nation, and may hit families in such distant, entirely uninvolved places as Zaire, Myanmar or Bolivia.

The most likely effects, already appearing, are on food and energy prices. For foods, most immediate impacts are on items containing wheat flour or cooking oil. Ukraine is a major wheat exporter and the world’s largest exporter of sunflower. For energy, people around the world see it at gas pumps and in airline tickets.

However, effects vary from commodity to commodity. This is true in international trade disruptions, including the trade wars of choice that President Donald Trump started early on. So it is useful to consider what causes the differential price impacts between commodities such as natural gas, crude oil and refined gasoline, cheese, chicken and soybeans.

Start with degrees to which goods are “fungible commodities.” This refers to how much a unit of the good from one source can replace one from other sources.

Number 2 yellow corn, unleaded 87-octane gasoline, refined white sugar and 12-percent-protein all-purpose wheat flour are all extremely fungible. It doesn’t matter if the gas in my car came from a refinery in Minnesota, Texas, Alberta or Saudi Arabia. The yellow corn may come from Mower County, Minn., Parana, Brazil, or South Africa. The sugar can come from cane grown in Florida or the Dominican Republic or from beets in Renville, Minn. Whether the flour was milled and blended from hard red spring wheat from the Red River Valley or winter wheat from Oklahoma, Argentina or Ukraine, it works fine in my pies and bread. In all cases, you would need a pretty sophisticated lab to find any differences.

Other items we find in the store aren’t very fungible. Gouda cheese from the Netherlands and Colby from Pine Island, Minn., may be traded internationally, but taste different. Ditto for commodities we don’t see, but use down the production line: heavy sour crude oil from Venezuela vs. light, sweet crude from Kuwait.

Navel oranges from California, Florida, Mexico and Israel seem fungible to me but not to a fruit broker. When I buy asparagus in the supermarket, I recall that, in 1982, I told a Peruvian agronomist his country would never succeed as an asparagus exporter. Now we eat Peruvian asparagus often and cannot distinguish it from California- or Mexico-grown. It’s all fungible to consumers.

Fungibility also relates to available substitutes. Asparagus isn’t cauliflower or Green Giant Niblett’s, but if people cannot get one vegetable among many it doesn’t rile them as much as gas going up a dime. If Thai rice exports were stopped, North Americans could eat more potatoes or pasta. That would be harder for rice-importing countries in Asia.

In addition to fungibility, there are transportability and storability. Crude oil is cheap to transport long distance. Pipelines are a known technology everywhere as are tankers and storage tanks. Natural gas can also be transported long distances cheaply in pipelines. But because it must be compressed and liquified, shipping it between continents and storing it in tanks is much more difficult and expensive than for crude or refined petroleum.

Grains and oilseeds are handled in bulk and moved in long trains or barges or huge ships. Most grains and some oilseeds can be stored for years, if necessary in dry warehouses or silos. Cheeses, citrus fruit and most vegetables require refrigerated transport and storage. Apples can be stored for months, asparagus only weeks, lettuce even less. Bottled wines are not fungible – with quality, price and availability highly subject to climate year and region – but also are storable for decades.

So, the more fungible, transportable and storable a commodity is, the less disruptions to global prices and markets from wars or natural disasters are felt. Yet these same factors ensure that the effects, even if moderated, can spread around the globe, even to countries never importing a bit from sources directly affected.

Crude oil isn’t perfectly fungible like soybeans, but fungible enough that reductions of Russian exports will affect fuel prices worldwide. Magnitudes won’t be identical, but no one will escape. Transport and storage difficulties mean a Russian cut-off of natural gas exports would hit western Europe hard, especially Germany. There is some regional production and pipelines from Algeria, but adjustments would be hard. As everywhere for all goods, adjustments are harder in the short term than the long.

A related question is the effects of trade embargoes on producers of exports rather than effects on consumers.

Soybeans are a good example. In 2016, Trump railed at the perfidy of China trade surpluses with us. Early on as president, he unilaterally ended NAFTA and limited imports from China. China retaliated by limiting imports from us, including farm products, especially soybeans.

Pundits pronounced gloom and doom for US farmers. One Purdue ag economist predicted that US soy growers would face prices 30 percent lower while Brazilians would prosper. I knew and deeply respected him, but his prediction was baffling. Soybeans are highly fungible, easy to transport and cheap to store. Markets are very efficient. Growers and traders and users can hedge risks in futures markets in Chicago and Sao Paulo or Dalian, China’s largest port for bulk imports. How could a large long-term differential develop?

It did not. A data set comparing cash Chicago prices to Brazil’s from 2006 into 2022 show that the price relationships, which are very close, did not vary at all before or after the US-China trade war began. Corn data seem similar. Yet the US Treasury made $28 billion in special payments, known as “Trump bribes,” in my hometown, to compensate US farmers for phantom losses due to Chinese perfidy.

When war or natural disaster destroys production or stops exports over an extended term, as Russia is trying to do to Ukraine, and as the US and Europe are trying to do to Russia, price effects to producers and consumers around the world will be greater than from a trade war between two countries. Russia’s invasion of Ukraine will raise food prices globally and, to the extent that overall Russian oil exports are reduced, similarly will raise fuel prices. But in all cases, fungibility of the product involved will be an important factor

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