Last year at this time, Montana was cutting its first $1 billion
wheat crop. It should have been cause for celebration, but farmers were nervous.
Grain prices that had quadrupled earlier in the year were heading downward. Fertilizer and fuel prices were racing upward through would-be profits like fire running up a rope. There had been a fragile bubble growing in the grain markets, inflated largely by a new crop of speculators flipping contracts for wheat.
"They were playing poker on the Chicago Board of Trade with our livelihoods," said Sen. Jon Tester, D-Mont.
Tester, who farms wheat near Big Sandy, knows the bubble's aftermath. Assured that high profits would last, farmers added extra zeroes to checks written and loans borrowed for business costs throughout 2008. By fall, farmers planting winter wheat were realizing that their crop wasn't even going to bring enough money to cover the cost of nitrogen, which had doubled over summer.
With prices crashing back to earth, there will be no $1 billion harvest in Montana this year. Profit margins will be razor thin, and some winter wheat farmers won't break even.
In light of the price collapse, the Senate Permanent Subcommittee on Investigations, on which Tester sits, is calling on commodities regulators to rein in excessive speculation in the wheat futures markets.
Betting on the farm, the subcommittee concluded, gave agriculture its own taste of toxic trading and contributed to a 10 percent increase in grocery prices on pasta, cereal and breads. And it more than doubled the inflationary rate for other food products. Rural farm states like Montana, where agriculture is the No. 1 industry, escaped the consequences of risky mortgage trading. They weren't so lucky with futures speculation, which the government now concludes created unwarranted costs and risks for farmers, grain elevators, millers and shoppers.
Futures contracts influence the price of everything, from $4-a-gallon gas to $3 loaves of bread, to breakfast cereal boxes that seem only to get smaller as the prices rise. And last year, as index traders flocked to futures to support hedge funds and pension accounts, the futures market took Americans for a hell of a ride.
The number of futures contracts for wheat, corn and oil shot upward, creating the illusion that demand was much higher than it truly was. Food essentials like wheat and corn more than tripled in price. Fuel doubled, and the daily cost of American life took a hit.
For a look at how that speculation in the commodities markets affected the economy of the West, consider farmers like Helen and Gordy Waller.
Married 57 years, the Wallers farm dryland prairie a mile and a half from Circle, where Gordy was born. The land is marginal and in spots extremely dry, tough soil from which to extract a living, let alone raise five children. Here, clouds can pass over for more than a month without shedding a drop of rain. Then without warning, a seam will rip in the bruised, gray curtain and the land directly below takes a big drink while the remainder of the field remains parched.
"We might get 20 bushels in some patches, might get 30 in others, might get 40 in some," Helen Waller said. "It didn't rain at all this year until the last month or so. We didn't get any in June."
Such variables in farming can make a roulette wheel seem like a sure bet. So the Wallers turn to the futures market to determine months ahead of harvest what they might be paid for their crop. It is their crystal ball, allowing them to engage in what the market calls "price discovery." They look at contracts made months in advance for the future delivery of a specific quality of the grain, at a particular time, in a particular amount, for a specific price. Then they match that information to their own expected harvest date and grain. It's what helps the Wallers determine how big of an operating loan they can take from the bank.
On weekends, when truck bumpers crusted in road dust and grasshoppers line the parking rows of Billings' shopping centers, it's because someone is confident the price they'll be getting for their crop in the fall is strong enough to support the trip.
At the nation's three large commodities markets for grain, thousands of contracts are traded daily. Those contract prices reflect the confidence of buyers certain they're paying the right rate for wheat, either for eventual delivery or for reselling the contract at a profit to yet another buyer.
When the market works, futures prices come close to predicting the actual cash price paid by mills and elevators across the country when crops come in. The futures market getting the cash price right within a few cents is crucial to the nation's food economy.
"It's very much a factor, and our producers watch it every day," said Lola Raska, Montana Grain Growers Association executive vice president. "The futures market is how all cash prices are determined."
Fast-food businesses, farmers and ranchers buying grain feed for cattle are all leery of spending more on raw food expenses than they'll eventually earn on whatever they produce. When the cash price of the day is significantly less than what the futures price predicted months ahead for that day, it means the people who bought wheat on future contract paid too much - in some cases, enough to wipe out years of profits.
"We lost millions of dollars last year when the market was tanking," said Roger Johnson, who last year as North Dakota agriculture commissioner oversaw finances for the largest flour mill and elevator in the United States.
From April to December of 2008, the North Dakota State Mill and Elevator lost $21 million as futures contracts it bought as a safety net turned out to be priced $2 to $3 a bushel more than the cash price. More than a loss to the mill, the losses hit the state budget. North Dakota built the mill 87 years ago in response to its farmers' being low-balled on grain prices by railroads and Minneapolis mills. Half the mill's profits go to the state general fund.
It wasn't the first time the state mill held an overvalued futures contract, but normally the difference between the cash price and the futures prices is about a dime a bushel.
"I would bet there are a lot of people who will need a number of years to dig out from last year's prices," Johnson said. "I know the losses at the mill were greater than many years of profits."
The assumption when contracts were traded, Johnson said, was that futures prices were accurately forecasting the eventual cash price for wheat, a simple forecast of future supply and demand.
But demand wasn't driving the market. The Senate Permanent Subcommittee on Investigations concluded that a few index traders, allowed by regulators to buy more contracts than normally permitted, locked in grain they really didn't want. Traders wanted contracts that could be resold at a profit. At the height of the market frenzy, they held 220,000 contracts, roughly half the paper moving through the Chicago Board of Trade. The trade engine, intended to reflect grain's true value, worked more like a fun house mirror.
For grain buyers like Jason Maisch of Great Harvest Bread Co., it was impossible to determine what was behind the high prices. Crop conditions and grain reserves throughout the world suggested a real wheat shortage, making it probable that record high prices truly were resulting from supply and demand.
"There were a lot of disasters around the world, with the Australian crop, the Egyptian crop," Maisch said. "The price was still in the $12 range, and there was a scare in the white flour market. But talking to millers, they said, 'No, we're not going to run out of white flour, we're fine.' Still, the price kept going up."
Great Harvest doesn't buy its bread on the futures market. It purchases grain directly from farmers in Montana's Golden Triangle. Maisch scrutinizes each farm's grain, fresh grinds it into flour and bakes it to see if it passes muster. The grain that is approved is distributed raw to more than 220 stores nationwide, where it is ground fresh daily.
The bakery still has to be competitive with whatever the futures market offers.
For Maisch, the rise in futures prices was meteoric, from slightly more than $6 a bushel in the fall of 2007 to $24 a bushel in March 2008. Great Harvest steered clear of the highest price but bought a lot of wheat in the $9-a-bushel range. In the worst days of the futures market, Maisch believes speculators might have driven up the price $11 to $14 a bushel, an astronomical amount for grain that in May 2007 sold for $4.86 a bushel.
There's a limit to how much of grain's inflated price can be passed on to consumers. Consequently, bread companies like Great Harvest have been slowly recovering from the price bubble.
Farmers had a different reaction to the market, Maisch said. Expecting another record ramp up, like the one created by the futures bubble in 2008, some held on to their 2008 crop after prices dropped, hoping to sell when the market skyrocketed again. It didn't.
"One of the unfortunate things going on this year is these growers have been very bullish and holding on and holding on, waiting for a better price." Maisch said. "Right now, there's a lot of wheat left to move from last year. Now, the market has been bearish, and I think it's going to continue to go down."
Roger Johnson resigned his state agriculture post to become president of the National Farmers Union, where he is advocating for market reform.
"Unfortunately, as speculators created this market bubble, many farmers ended up locking in higher input and feed costs," Johnson said. "Now, following the market collapse, farmers and ranchers are struggling to pay these higher costs, and rural communities, in turn, are feeling the pinch."
Johnson said the futures market should be transparent, so farmers know when speculation, not demand, is driving up prices.
Tester and members of the Senate Permanent Subcommittee on Investigations want the Commodities Futures Trading Commission to stop allowing traders to buy more contracts than rules allow. They've also told regulators to begin looking at other food commodities for speculation symptoms.
Helen Waller would like to see only farmers and true wheat buyers entering futures contracts. But economists say speculators are essential. The market needs people willing to risk their money in hopes of profiting from commodities. Those people buy contracts for grain that otherwise wouldn't sell. And those sales make it much more difficult to push the market price around under normal conditions.
"You need all those players, and they serve many functions," said J.C. Hoyt, of CashGrainBids.com, a Bozeman company that tracks cash prices at elevators nationwide.
Hoyt said the reforms are in order, but any change to the market will affect the strategies of investors. The futures market won't simply be more stable as a result of reforms; it will just be different.
Gary Brester, an agriculture economist at Montana State University, said blaming the futures market for losses is no more reasonable than a gambler blaming misfortunes on a casino. Bester's standard advice is for farmers and buyers alike to find a price they can live with and not chase the higher profits. The futures market was intended to reduce risk. Only when people began chasing higher profits did the market derail.
"If you're there to reduce your risk, you will not lose the farm on that deal. You might lose, but you won't lose the farm," Brester said. "Everyone in this community that says it's the futures market's fault. They were not in the market hedging, they were speculating."