How Obama's Budget Will Affect Commodities

Farm subsidies get headlines. In Iowa, they play well. In urban America, they're anathema. And the budget tackles them straight on, with a number of proposals that will directly affect agricultural commodities:

* A phase out of direct payments to farmers with sales revenues over $500,000 a year. The phase-out would happen slowly over the next three years.
* A $250,000 commodity program payment limit (a cap on any kind of direct payments, no matter how big you are).
* A reduction of crop insurance subsidies.
* The elimination of cotton storage credits.
* A decrease in funding of 20% for the Market Access Programs (MAP) - the overseas agriculture marketing programs.

As you might expect, the various agricultural lobbying groups are up in arms about all of these, because these proposals, while complicated, all mean the same thing: less money for farmers (especially BIG farmers).

On the subject of direct payments, the National Wheat Growers Association points out that while only 5% of the farms counted by the USDA have sales over $500,000 they are responsible for 74% of all agricultural sales. They also argue that the direct payments help farmers qualify for the financing they need for operations - equipment, seed and fertilizer. Reuters put it this way:

'Farmers say the direct payments help them maintain credit with local banks as a form of dependable cash flow, and help farmers who lose crops to drought or disease. They are considered trade friendly, non-distorting to price or production, and so small in sum in comparison to other budget items that farmers and their advocates say there is little upside to eliminating them.'

For the ag investor, of course, the real question is how this actually hits supply and demand, and thus prices, should all of this get finalized in the 2010 budget?

If direct payments are truly 'non-distorting to price or production' then the elimination of the payments should have no impact on commodity prices. Of course, if the programs actually have zero impact on price or production, it bears the question: what they heck good are they doing anyway?

Regardless, if in the long run farmers are unable to get credit for the purchases they need, then inevitably some level of production will suffer, either through smaller harvests of starved crops or due to lower crop plantings. Of course, if that happens, commodity prices will rise and farmers will once again have incentive to plant larger crops.

It comes down to just how pointless you think the subsidies were in the first place. Totally pointless? No impact. Actually relevant? This makes prices go up, long-term."