Now We Know: Ethanol Caused the 2008 Financial Crisis and the Little Depression

In the latest issue of the Journal of Economic Perspectives, now freely available here, Brian Wright, an economist at the University of California, Berkeley, has a great article, summarizing his research (with various co-authors including, H Bobenrieth, H. Bobenrieth, and R. A. Juan) into the behavior of commodity markets, especially for wheat, rice and corn. Seemingly anomalous price movements in those markets – especially the sharp increase in prices since 2004 — have defied explanation. But Wright et al. have now shown that the anomalies can be explained by taking into account both the role of grain storage and the substitutability between these staples as caloric sources. With their improved modeling techniques, Wright and his co-authors have shown that the seemingly unexplained and sustained increase in world grain prices after 2005 “are best explained by the new policies causing a sustained surge in demand for biofuels.” Here is the abstract of Wright’s article.

In the last half-decade, sharp jumps in the prices of wheat, rice, and corn, which furnish about two-thirds of the calorie requirements of mankind, have attracted worldwide attention. These price jumps in grains have also revealed the chaotic state of economic analysis of agricultural commodity markets. Economists and scientists have engaged in a blame game, apportioning percentages of responsibility for the price spikes to bewildering lists of factors, which include a surge in meat consumption, idiosyncratic regional droughts and fires, speculative bubbles, a new “financialization” of grain markets, the slowdown of global agricultural research spending, jumps in costs of energy, and more. Several observers have claimed to identify a “perfect storm” in the grain markets in 2007/2008, a confluence of some of the factors listed above. In fact, the price jumps since 2005 are best explained by the new policies causing a sustained surge in demand for biofuels. The rises in food prices since 2004 have generated huge wealth transfers to global landholders, agricultural input suppliers, and biofuels producers. The losers have been net consumers of food, including large numbers of the world’s poorest peoples. The cause of this large global redistribution was no perfect storm. Far from being a natural catastrophe, it was the result of new policies to allow and require increased use of grain and oilseed for production of biofuels. Leading this trend were the wealthy countries, initially misinformed about the true global environmental and distributional implications.

This conclusion, standing alone, is a devastating indictment of the biofuels policies of the last decade that have immiserated much of the developing world and many of the poorest in the developed world for the benefit of a small group of wealthy landowners and biofuels rent seekers. But the research of Wright et al. shows definitively that the runup in commodities prices after 2005 was driven by a concerted policy of intervention in commodities markets, with the fervent support of many faux free-market conservatives serving the interests of big donors, aimed at substituting biofuels for fossil fuels by mandating the use of biofuels like ethanol.

What does this have to do with the financial crisis of 2008? Simple. As Scott Sumner, Robert Hetzel, and a number of others (see, e.g., here) have documented, the Federal Open Market Committee, after reducing its Fed Funds target rates to 2% in March 2008 in the early stages of the downturn that started in December 2007, refused for seven months to further reduce the Fed Funds target because the Fed, disregarding or unaware of a rapidly worsening contraction in output and employment in the third quarter of 2008. Why did the Fed ignore or overlook a rapidly worsening economy for most of 2008 — even for three full weeks after the Lehman debacle? Because the Fed was focused like a laser on rapidly rising commodities prices, fearing that inflation expectations were about to become unanchored – even as inflation expectations were collapsing in the summer of 2008. But now, thanks to Wright et al., we know that rising commodities prices had nothing to do with monetary policy, but were caused by an ethanol mandate that enjoyed the bipartisan support of the Bush administration, Congressional Democrats and Congressional Republicans. Ah the joy of bipartisanship.


34 Responses to “Now We Know: Ethanol Caused the 2008 Financial Crisis and the Little Depression”

  1. 2 Ilya February 7, 2014 at 10:46 am


    Are you saying contractionary monetary policy caused the financial crises, and NOT the subprime housing mortgages crisis? In other words, had the Fed not tightened in 2008, the economy would not have crashed in the fall?


  2. 3 Ilya February 7, 2014 at 10:48 am

    I meant to say… “are you saying it was NOT the subprime mortgage housing crisis which caused the financial crisis, and that the cause was REALLY contractionary monetary policy?”


  3. 4 Lord February 7, 2014 at 10:50 am

    They consider the ratio of output prices to input prices, but not the change in input prices, not as a cost driver but as an investment draw. Farming is an energy business and higher energy prices will increase demand for output, so was it mandates or higher energy prices? I don’t see this answering that.


  4. 5 Marcus Nunes February 7, 2014 at 10:56 am

    David, that makes sense but is not the whole story. What about the price of all the other commodities, including oil, minerals and metals going up in tandem from the early 00s?
    Associate that with the 7 or 8 fold increase in China´s imports after gaining access to the WTO in December 2001.


  5. 6 David Glasner February 7, 2014 at 11:35 am

    Lars, Thanks.

    Ilya, I am saying something like that. The financial problems created vulnerabilities in the financial sector. If the economy had not contracted so rapidly in the third quarter, before Lehman collapsed, the financial crisis might well have been avoided.

    Lord, Why do rising energy prices increase the demand for agricultural output?

    Marcus, You are right. It’s not the whole story. Nevertheless, I think it is a key element in the overall picture. I think food prices account for a very large fraction of the CPI, which is what the FOMC was obsessing about in 2008.


  6. 7 Lord February 7, 2014 at 1:22 pm

    It is fine to blame it on ethanol, but not on the mandate. It is hard to believe the mandate would have any effect unless it were economic to begin with. At high enough real oil prices, grains will be converted to ethanol whether there is a mandate or not and whether you like it or not.


  7. 8 minglingmike February 7, 2014 at 7:52 pm

    A cause is not the same as a trigger, but ethanol was neither. The cause of the crisis was the fact that the system as it now stands (still!) is inherently unstable. That would be ok if we could just let the faulty institutions go bust. But we cannot. And there’s no mandate from private power to fix the system. That will happen if and when the people decide to change it. Currently, “the basic principle of our economy is that the public pays the costs and takes the risks, and profit is privatized.” (Chomsky). So you could argue that crises are more or less taken into account. Just another way to shake people up, and shake down governments for public funds. The crisis was triggered by the subprime bubble-burst, I don’t think there’s any doubt about that. What Ethanol policies contributed was primarily to help boost profits in food speculation. Many of Europe’s pensions were saved by pushing them up. It’s where a lot of the money went after the bailout. Many Swiss pension funds, and whoever (else) had the appropriate products from Deutsche Bank, and possibly others. Meanwhile, Chinese and Indian investors bought up large tracts of Africa. Did I miss something?


  8. 9 Peter Schaeffer February 7, 2014 at 10:17 pm

    This could only have been written by someone with scant knowledge of commodities. Corn in 2006 was at it’s all-time (in world history) low price in real terms. It shouldn’t be too surprising that it went up from there.

    Even after the run-up in corn prices, they were (are) well below the average level for the 20th century. See for some historical data.

    Let me also point out what should be obvious. If a 2% Fed Funds rate (cut to 1.5% on 10/8/2008, 1.0% on 10/29/2008, and 0-0.25% on 12/16/2008) was somehow fatal, then maybe, just maybe the economy had deeper problems.

    Another non-trivial point is that the ethanol mandate wasn’t quite as significant as is generally believed. Gasoline has to meet certain octane specifications. After MTBE was banned, ethanol became the blending agent of choice to manufacture gasoline. In other words, ethanol became something the oil companies needed.


  9. 10 James Wattengel February 8, 2014 at 2:42 am

    I think that you omitted a key component of the the fact that the US ethanol policy: the high import tax on ethanol prevented the use of less expensive and more efficient ethanol from sugar cane. The ethanol mandated without imported cane ethanol is no more than just a subsidy for corn farmers.


  10. 11 Benjamin Cole February 8, 2014 at 6:09 am

    Top-knotch blogging, and Marcus Nunes is right too.

    The bottom-line story is the Fed accepted an antique argument that rising commodities prices (and the ever-magical gold, do not forget) “signaled” rising general prices.

    The larger story is even still larger: The Fed will embrace almost any fear or argument that inflation is just about to escape, and run out of control….


  11. 12 peterschaeffer February 8, 2014 at 8:49 am

    This is analysis was written by someone with little knowledge of commodities. A few notable points.

    1. Corn prices in 2006 were at their all-time low. That is, all-time low in the history of the world. Standard mean reversion suggests that a rise was likely.

    2. Even after corn prices rose, they were still well below the average real price for the 20th century. Indeed, they still are far below the 20th century average (even though ethanol production remains very high).

    3. The 2007/8 corn price spike matched (in real term) the spike of 1995/96 and was well below the peak of 1983. Of course, 2007/8 prices were far below the 20th century peaks.

    4. The Fed cut the Fed Funds rate to 2% on 2008/04/30, 1.5% on 2008/10/8, 1% on 2008/10/29, and 0-0.25% on 2008/12/16. Let me “politely” suggest that an economy that couldn’t withstand 2% (and falling) interest rates had “problems” bigger than corn prices. A reading of the rise and fall of AIG Financial Products tells a much more germane story.

    5. The use of ethanol in gasoline is not simply a consequence of the federal mandate and historical subsidies. Gasoline must be manufactured to certain technical specifications, notably including octane. Ethanol is needed as a blending agent to meet these requirements. Historically, lead, aromatics, and MTBE were used. However, each of these was either banned (lead, MTBE) or discouraged (aromatics) for environmental reasons.

    Blaming ethanol for a global financial crisis is not well founded. It is however, another example of the “free market” absolutism and libertarian idolatry that plagues the U.S. The crash of 2008 in the U.S. and abroad was a consequence of pervasive market failures and ill-considered public policies (housing, trade, etc.) at home and abroad.

    Not an easy thing for many on the right (and left) to accept. Hence the scapegoating of ethanol.


  12. 13 peterschaeffer February 8, 2014 at 8:55 am

    A very simple point, that should be obvious is that energy markets dwarf food markets. The corn price spike in 2007/8 had little impact compared to the contemporaneous boom in oil and natural gas prices. Of great importance in this context, is that ethanol production diminished (slightly) the energy price explosion.

    Even if you accept the inflation / Fed restraint / crash model, energy, not ethanol is the rational culprit.


  13. 14 Rob February 8, 2014 at 9:27 am

    If it’s true that ethanol policies caused more people to die of starvation (in the millions as I think I’m remembering from one analysis) the last decade, effectively, saw the largest instance of human sacrifice for the weather in human history.


  14. 15 AlanDownunder February 8, 2014 at 8:20 pm

    I’m minded of the apocryphal butterfly flapping its wings somewhere in the Amazon. Wouldn’t it be more useful to ponder the conditions that made the global economy prone to the phase change that it (may have) precipitated? Proximate cause is a concept of limited value.

    Not that I disagree that bipartisan support for corn ethanol production was nothing but an agricultural subsidy behind a trade barrier against cane ethanol. A constitution giving Wyoming the same Senate representation as California is a condition that made the US prone to such a dumb subsidy.


  15. 16 JP Koning February 9, 2014 at 4:05 am

    So a small group that included wealthy landowners, biofuels rent seekers, faux free-market conservatives, the Bush administration, and Congressional Democrats & Republicans played the role of the insane Bank of France? ie. they pushed the economy’s medium-of-account higher.


  16. 17 peterschaeffer February 9, 2014 at 3:41 pm


    California’s senators have a long record of supporting legislation to promote and expand ethanol use. See below.

    The National Energy Conservation Policy Act of 1978 was the first federal legislative ethanol subsidy. It allowed for a 40-cent tax exemption per gallon of ethanol, according to Purdue University. It passed the Senate 86-3. Both California Senators (Cranston-R, Hayakawa-R) voted in favor of it.

    The Surface Transportation Assistance Act of 1982 increased the tax exemption to 50 cents per gallon of ethanol.
    The 1990 Omnibus Budget Reconciliation Act extended the ethanol subsidy to 2000 but decreased the amount to 54 cents a gallon. This bill was introduced by Rep. Glenn Anderson [D-CA32]. California Senators (Cranston–R, Hayakawa-R) voted in favor of it. Note that Cranston only voted in favor of the final conference report. He didn’t vote (yes or no) in any of the prior votes.

    The alternative motor fuels act of 1988 added incentives for using ethanol. Cranston-D and Wilson-R sponsored this bill.

    The Clean Air Amendments (CAAA) of 1990 mandated additional ethanol blending. Both California senators voted in favor (Cranston-D, Wilson-R)

    The 1990 Omnibus Budget Reconciliation Act extended the ethanol subsidy to 2000 but decreased the amount to 54 cents a gallon. Cranston-D voted in favor. Wilson-R voted against.

    The 1998 Transportation Efficiency Act of the 21st Century extended the ethanol subsidy through 2007 but reduced it to 51 cents per gallon by 2005. Both California Senators voted in favor (Boxer-D, Feinstein-D).

    Bush’s signature on the American Jobs Creation Act of 2004 changed the way the modern ethanol subsidy worked. Instead of offered a straight tax credit to producers, the legislation allowed for the “blender’s credit.”. This bill passed the Senate 69-17. A majority of both parties voted in favor. Both California Senators votes against (Boxer-D, Feinstein-D).

    The Energy Policy Act of 2005 accelerated ethanol production at an unprecedented rate. Both California Senators voted in favor (Boxer-D, Feinstein-D).


  17. 18 AlanDownunder February 9, 2014 at 7:20 pm

    Thanks for the enlightenment, Peter, but I was instancing California not as a sane energy/subsidy Senate vote but merely as the most populous state. My larger and intended (and trite) point remains that the Senate is skewed agrarian by its undemocratic means of representation. You might also have detected my tendency to take account of predispositive structural factors as well as proximate cause.

    No surprise that Feinstein and Boxer were onside. An electoral plus for them with their consituent farmers and knee-jerk greenies and a minus for them only with the cognoscenti wherein, on this issue, I include you.


  18. 19 peterschaeffer February 10, 2014 at 8:09 am

    It is not my intent here to take a position for or against the ethanol subsidies that exist now or have existed in the past. However, it is my goal to deflate unreasonable claims for or against ethanol. A few notes.

    1. The ethanol subsidy is $0.45 per gallon or $1.25 per bushel (allowing for 2.77 gallons of ethanol per bushel of corn). Even if we assume that the entire $1.25 per bushel showed up as higher corn prices, the effect on the overall price level is rather small. Corn production from 2006-8 was 10.5, 13.0, and 12.1 billion bushels.

    A related point is total corn output has grown as fast (roughly) as corn utilization in ethanol production. A few numbers should help. corn output was 2.21 billion bushels in 1940, 2.76 billion in 1950, 3.91 billion in 1960, 4.12 billion in 1970, 6.64 billion in 1980, 7.93 billion in 1990, 9.92 billion in 2000, 13.9 billion bushels in 2013. Most of the increase in output has come from higher yields (up 5 fold since WWII), not more acres.

    2. As I have stated a few times, the ethanol subsidy has not been the only driving force behind ethanol blending for some time now. The bad on lead and MTBE, and the restrictions on aromatics, have forced oil refiners to blend ethanol to meet octane requirements. The rules are actually quite a bit more complex, because gasoline has minimum oxygen requirements (for air quality reasons). Originally, the oil industry favored MTBE as an oxygen (and octane) blending agent. However, MTBE was banned in many states and U.S. production fell from 47.374 million barrels in 2005 to 15.304 million barrels in 2012. With MTBE partially banned, ethanol became even more important to meet octane and oxygen requirements.

    3. The politics of ethanol are long and tangled. However, I will say that I can find no systematic differences in how the Senate and House have viewed ethanol. Partisan differences appear. However, they are not (generally) of the Democrat vs. Republican variety. More of the Democrats oppose the White House when the White House is occupied by a Republican and vice versa.

    4. Corn prices are now around $4.50 a bushel. This is at the low end of historical real corn prices (but not the bottom). To put this in perspective, the real price of corn at the bottom of the Great Depression was $4.35 a bushel.

    5. Ethanol production remains at quite high levels. The last data point available is 27.915 million barrels for 11/2013. The peak was 29.718 million barrels in 12/2011. Apparently, high levels of ethanol production are compatible with quite low corn prices.

    6. Global commodity prices boomed from 2006 to late 2008. The boom / bubble included metals, energy and agriculture. Given that petroleum (oil and natural gas) is a much bigger business than farming (in the U.S.), the CPI impact of the energy boom / bubble must have been commensurately greater. Note that the EPA estimates crop revenues in the range of $143 billion for 2013. The U.S. petroleum business is clearly many times larger than crop production (gasoline alone is probably at least twice as large).


  19. 20 David Glasner February 10, 2014 at 2:01 pm

    Lord, Sorry, don’t follow you. If ethanol is not economic, but is mandated, why would it’s use not have effects. If the government mandated destroying half the corn crop, it would be uneconomic and would have very harmful effects. It’s not clear that there is any real price of oil that would make ethanol from corn economical, because the amount of energy expended in producing ethanol from corn is almost as great as the energy content of ethanol from corn. A gallon gasoline generates 50% more btus than a gallon of ethanol. Ethanol from sugar is more economical and might have been worth substituting, but foreign ethanol was specifically excluded from the ethanol mandate.

    minglingmike, Obviously in the real world no single cause operates in isolation. When we refer to something as the cause of some event, it is a shorthand for saying that thing made the event more likely to occur. Actually the subprime bubble busted over a year before the financial crisis after the Lehman collapse. The economy had to go into a recession first, and the recession had to get really bad. And the reason that it got really bad is that the Fed took no further action to ease monetary conditions after its March 2008 rate even though the economy and employment were rapidly deteriorating. The reason the Fed took no further action was because of misplaced concern about an unanchoring of inflation expectations associated with the commodity price boom that was the result of rapidly rising energy and food prices. We now know that rapidly rising food prices were caused by the ethanol mandate.

    Peter, You may be an expert in commodities prices , but you are obviously using your expertise in a tendentious fashion. Corn prices may have been at (or near) an all-time low in 2005, but they more than tripled by 2008, exceeding by at least a third the previous all-time high set in 1995.

    See this graph

    Your point about the average price of corn over the 20th century is irrelevant to the effect of a three to four-fold increase in corn prices between 2005 and 2008. Commodity prices have generally fallen over time in real terms.

    Nobody said that the economy had no other problems. It is precisely because it was in a vulnerable situation that an easier monetary policy was called for in 2008 when it could have prevented a financial collapse. As James points out below, MTBE could have been replaced by imported ethanol from Brazil at a very much lower price, but that would not have suited the domestic ethanol lobby.

    James, Thanks, you are exactly right.

    Benjamin, Thanks, and you are right too.

    Peter, As the chart above demonstrates, we are not even remotely talking about mean reversion.

    Your historical comparisons are just as irrelevant as comparing the price of a computer today with the price of a computer in 1983.
    I agree that increases in energy prices were more significant than in food prices. But the FOMC was citing both in justifying their refusal to cut rates further in the face of a worsening recession. Additionally, the increases in food prices could more plausibly be attributed to Fed policy than the increase in energy prices which are to some significant extent under the control of the oil cartel.

    Rob, Sorry, I don’t understand.

    Alan, I think it’s hard to argue that the US Senate is the source of ability of special interests to take extract rents from the rest of the population. I think it’s a problem in any democracy. I am guessing that Australia has some pretty powerful special interests that have a lot of influence over the legislative process.


  20. 21 peterschaeffer February 10, 2014 at 10:02 pm


    All of my posts have attempted to make a set of related points.

    1. The $0.45 per gallon subsidy for ethanol, that people make so much of, could not and can not reasonably account for all of the effects observed in the corn market from 2005 onwards. Given the corn to ethanol conversion ratio, that’s equal to $1.25 per bushel as an upper bound.

    2. The octane/oxygen legal mandates were almost certainly a more significant factor in driving ethanol adoption as a gasoline blending agent. Notably, the oil industry did not favor ethanol at the outset and preferred MTBE. MTBE is made from a C4 (4-carbon) FCC (Fluidized Cat Cracker) output stream and can be blended at a refinery (because it is not hygroscopic) and shipped via pipeline. By contrast, ethanol has to be blended at a gasoline terminal. Eventually, MTBE was banned in many states (including the big ones) leaving ethanol as the octane/oxygen blending agent of choice.

    However, even without the octane/oxygen mandates, the value of any gasoline blending feedstock went up as crude oil prices soared in the 2000s. In other words, even with no regulatory mandates the value of ethanol for gasoline production was going to rise in tandem with global crude oil prices.

    3. In a typical recent year, about 29% of the corn crop (not half) is consumed to produce ethanol. Higher numbers typically ignore that a substantial fraction (1/3rd) of the corn that goes into an ethanol plant comes out as non-ethanol products (DDG).

    4. Actually, ethanol production does have a positive energy yield. Check Wikipedia for a long list of studies and statistics. However, the net energy balance is actually not very relevant. Ethanol plants don’t use petroleum (as in liquid petroleum) to produce ethanol. They take corn and natural gas as inputs and produce ethanol (and DDG) as outputs. In other words, they transform materials than can not be used as transportation fuels into a transportation fuel. Since transportation fuels have much higher values per joule than solids (corn) and gases (natural gas), the economics are net dependent on any net energy balance.

    To use a modest analogy, a typical oil refinery has a negative energy balance. The joule content of the outputs is below the joule value of the crude oil. However, it can still be profitable because very few machines can run on raw crude oil.

    5. The energy density of ethanol is 67% of gasoline, not 50%. See Wikipedia for a source.

    6. A tariff was imposed on imported ethanol so that the subsidy would accrue to U.S. producers. In any case, it was small on a per-bushel basis. Note that foreign ethanol was not excluded from the blending mandate. It was simply ineligible for the per gallon subsidy.

    7. The statement “We now know that rapidly rising food prices were caused by the ethanol mandate” is not clearly true. As stated above, the value of ethanol as a gasoline blending agent would have tracked crude oil prices even without any regulatory intervention. The mandates and subsidy were (and are) germane. However, rising crude oil prices make all transportation liquids more valuable.

    8. The average (nominal) price for corn per bushel in 2005 was $1.96. In 2008, it was $4.78. That’s not a tripling. However, 2005 was a low point. The average nominal price in 2004 was $2.47 and $2.27 in 2003. The all-time low (in real terms for all of human history) was 2000 at $1.86. Note that the average nominal price in 1995 was $2.56. However, in 1996 the average nominal price was $3.55. In real terms, the 1996 peak slightly exceeded the 2008 high point.

    9. Imported ethanol from Brazil could have never replaced the U.S. supply. U.S. ethanol production exceeded Brazil’s output from 2006 onwards. By 2009, U.S. ethanol production was 50% greater than Brazil. Indeed, the U.S. exports ethanol (huge quantities) to Brazil in some years. Even if 100% of Brazilian ethanol was shipped to the U.S. it would not have been enough. Of course, Brazil was never going to export more than a modest fraction of their production.

    10. As sanity check, let’s see how much of global grain production was diverted into ethanol production in 2008 by the U.S. ethanol program. In 2008, global grain production was 2.521 billion metric tons of which 403.5 million tons were produced in the U.S. Note that these numbers exclude global production of 1.959 billion tons of sugar (only 49.427 million tons in the U.S.). From 2006 to 2008, U.S. grain consumption (corn) for ethanol production grew from 35.9 million tons to 62.8 million tons. That’s an increase of 26.9 million tons. From 2005 to 2008, the gain (in corn used to produced ethanol) was 35.7 million tons.

    Both numbers are just over 1% of global grain production. Is it really plausible that a 1% shift in global grain product into ethanol production in the U.s. transformed a global market for grains? Note that these percentages would be considerably smaller if I included sugar production (which can be used to produce ethanol and is also used as food in much of the world).

    Moving on, is it really plausible to suggest that the weight of a 2% Fed Funds rate was so burdensome that the economy cratered? Note that real interest rates were negative in 2008 with inflation running at 3.8% (2.8% for 2007, 3.2% for 2006).

    Perhaps an economy that couldn’t withstand a negative real Fed Funds rate of -1.8% had bigger problems than Fed policy. Perhaps deep market failures in finance, real estate, consumer borrowing, trade, immigration, etc. had created a House of Cards doomed to fall in faint breeze.

    To test this theory lets compare apples and hand grenades, specifically corn and AIG. From 2005 to 2008 corn rose by $2.82. The corn crop was roughly 12 billion bushels in those years so the increase in value was roughly $33.84 billion dollars. By contrast, AIG alone lost $99 billion in one year (2008).

    Let me offer a “different” model of “what went wrong”. This model suggests that pervasive market failures in finance, real estate, consumer borrowing, trade, immigration, etc. created a debt-ridden, fragile economy that was doomed to fail, with the only question being when.

    From 2000 onwards the dominant political economy model of the United States was based on the deliberate hollowing out of the productive core of the U.S. via trade, outsourcing, etc. Note that the U.S. trade deficits in this period reached the highest levels in U.S. (6% of GDP) and world history (in dollars). Jobs losses in the productive sector were large. See “Import Competition and the Great US Employment Sag of the 2000s” for some detailed information. Of course, this was quite bad for the U.S. economy. For ordinary Americans, the situation was considerably worse, because of massive, on going immigration (legal and illegal). The overall job market was dismal (driven down by trade policy). Given the flood of immigrants, employment for Americans fell with stunning declines in the employment / population ratio and LFP (Labor Force Participation).

    The political system was not unaware of the pervasive malaise consequential to its preferred policies. but was (and remains) deeply wedded to the status quo. The political system (both parties) responded to the quasi-crisis by promoting an ever larger bubble in real estate, sub-prime real estate, and more generally FIRE (Finance, Insurance, Real Estate). Real estate prices soared and lending standards were relentlessly ratcheted down. Finance as a percentage of corporate profits reached unimaginable levels (44% in 2002).

    Real estate was a natural target for a bubble given the non-tradable nature of the product. Real estate prices soared and investment in real estate (construction) rose accordingly. The rise in real estate investment created enough jobs to partially offset the economic hollowing out described above. However, the true value of the real estate bubble was in MEW (Mortgage Equity Withdrawal). The bubble turned homes into ATMs that sustained consumption growth considerably greater than income growth. At its peak, MEW was funneling most of a trillion dollars a year into the economy.

    Of course, the FIRE bubble, the housing bubble, and the MEW bubble (tied to the housing bubble) were all based on debt and leveraging, not investment in productive assets and new sources of real income. Like all debt bubbles this one came to a devastating end.

    What makes this political economy credible is not just the historical accuracy of the facts, but the scale of the numbers. Trade deficits did run to large fractions of a trillion dollars per year. MEW approached a trillion a year at peak. Sub-prime lending was many hundreds of billions or more. These are numbers big enough to cripple an economy as large as the United States (which they did). Compare them with a $33.84 gain in the value of the corn crop and you have your answer.


  21. 22 peterschaeffer February 10, 2014 at 10:12 pm

    Correction – “a $33.84 billion gain”


  22. 23 peterschaeffer February 11, 2014 at 10:25 am

    Let’s look at this yet another way. Oil peaked in 2008, at $145 per barrel or $3.45 per gallon. Since a net bushel of corn yields 4.155 gallons of ethanol worth $14.33, we shouldn’t be surprised that soaring oil prices dragged corn prices higher.

    In other words, even with no regulations, no mandates, and no air quality rules rising oil prices should have increased corn prices more than the actual change in corn prices.

    Of course, the actual calculations are considerably more complex. The cost of producing gasoline is not the price of crude oil divided by 42. The value of corn fed into the ethanol conversion process is not equal to the value of the output ethanol. The conversion process does not work (exactly) the way I have described it.

    Still the point should be clear. Rising liquid petroleum prices provide a sufficient rationale for rising corn prices. That said, the general global boom / bubble in commodities (grains, metals, and energy) still looks like the best explanation.


  23. 24 marksadowski February 11, 2014 at 11:31 am

    I have a comment on Peter Shaeffer’s historical corn numbers.

    These evidently come from the National Agricultural Statistics Service (NASS). The NASS has “price received for corn grain” in the US at a monthly frequency from January 1908 (and at an annual frequency from 1866).

    Adjusting this by the CPI (not seasonally adjusted) one finds that real corn prices increased by 179.1% from November 2005 to June 2008. Using NASS data, this is a larger increase within any 31 month period with the sole exception of the 343.6% increase from December 1932 to December 1934, which was of course largely during the initial recovery from the Great Depression.

    For real corn prices in a monthly frequency prior to January 1908 one can use Wholesale Price of Corn for Chicago (04005US16980M280NNBR) and combine that with the General Price Level for United States (M04051USM324NNBR):

    One finds that real corn prices roughly tripled from early 1862 to late 1864 and again from February 1866 to October 1867. The first was of course during the Civil War, and the latter immediately after.

    In short, apart from the Civil War and the Great Depression, the increase in real corn prices from 2005 to 2008 has never been exceeded in US corn price history.

    P.S. A good paper on historical real prices of commodities (which addresses the long downward trend in real grain prices) see David Jacks:

    Click to access w18874%20(typology).pdf


  24. 25 AlanDownunder February 11, 2014 at 3:50 pm

    “Alan, I think it’s hard to argue that the US Senate is the source of ability of special interests to take extract rents from the rest of the population. I think it’s a problem in any democracy. I am guessing that Australia has some pretty powerful special interests that have a lot of influence over the legislative process.”

    Too right, David. And we have the same particular one as you: equal constitutionally entrenched senate representation for very unevenly populated states – as the price of federation.

    But you addressed my aside rather than my point about phase change. You could very well be right about what lit the fuse, but isn’t the more relevant story the one about the packing of the powder keg?


  25. 26 peterschaeffer February 11, 2014 at 9:29 pm


    Thank you for your comments. Serious comments based on real research are not common and appreciated (no sarcasm implied or intended).

    I appreciate that you are using monthly data. Of course, monthly data has more variability than yearly data. Daily data would have more still and indeed an actual trading history would show the biggest spikes (up and down). However, the big picture topic is whether ethanol policy drove corn prices which in turn drove the CPI which in turn prevented the Fed from cutting the Fed Funds rate (2% nominal, -1.8% real) further in early 2008.

    There are a lot of links in that chain and in my opinion, several are broken (as stated above).

    However, let me just address corn price variability. corn prices are indeed highly variable. From 2005 to 2008 corn prices rose by 143% in nominal terms and 121% in real terms. However, in just two years, from 1972 to 1974, corn prices rose by 150% in nominal terms and 112% in real terms. The price rise after 2005 was only modestly greater and it took 3 years, not 2.

    However, we can also look at these periods using monthly data. From 2005/11 to 2008/06 corn rose from $1.77 per bushel to $5.48. That’s a gain of 209.6% in nominal terms and 179.6% in real terms. By contrast, from 1971/11 to 1974/10 corn rose from $0.97 to $3.45 per bushel in nominal terms. That’s a gain of 254% in nominal terms and 183.5% in real terms.

    A very different perspective is by looking at the value of the corn crop as a percentage of GDP. This allows up to use nominal dollars for prices and GDP without comparing apples and oranges. In 2005, the value of the corn crop was 0.167% of GDP. By 2008, it had risen to 0.393% of GDP. However, that gain reflected both higher prices and higher volumes. Adjusted for higher volumes, the 2008 corn crop was worth 0.361% of GDP.

    I mentioned above a rather long chain in alleged causal linkages. It is really plausible that a 0.2% of GDP change in the corn brought down the edifice of the U.S. economy? Note that inflation was running around 3.8% back then (not 0.2%).


  26. 27 David Glasner February 12, 2014 at 10:23 am

    Peter, Thanks for your very detailed response, which presents a lot more information than I can process in a short time, so I can only give you a shorter response than I would have liked.

    First, I am obviously not that knowledgeable about commodity markets and I was taking Wright’s paper in JEP and the other papers on which it was based as authoritative. Obviously, if his conclusions are not solid, my reliance on him was not warranted.

    Second, your points about the extent of the rise in corn prices in 2008 are irrelevant. I could make a similar argument pointing out that the real price of gasoline was less in 2008 than it was in 1979-80. So what?

    Third, your point that ethanol use tracks the value of crude oil may or may not be true. If it is true, please explain to me why ethanol requires a huge subsidy and a legal mandate to be competitive with gasoline. I am not a fan of MTBE, but I very much doubt that agricultural interests did not have any influence on the decisions taken to ban its use. You have not explained to me why a rising price of oil is sufficient, without a mandate and a subsidy, to cause ethanol to be blended into gasoline.

    Fourth, Your citation of the small share of total world corn output devoted to US ethanol production ignores the fact that other countries also have similar policies promoting the use of ethanol and the very inelastic demand for basic grains like corn, so that a small shift in the supply demand balance can produce large swings in price.

    Fifth, The energy balance is relevant, because there is little reason to believe that ethanol would be used without a subsidy, a tariff on imports, and a mandate.

    Sixth, Brazil is not the only actual or potential source of ethanol made from sugar.

    Seventh, Yes, it is entirely plausible that a rapidly contracting economy would require a negative real interest rate to prevent a crash. In addition measured CPI inflation is a bad way to calculate the real interest rate for a variety of reasons, including the fact that it was distorted by supply-side factors like rise in food and energy prices.

    Eighth, Everybody knows, and I already acknowledged to you, that the US economy had very significant problems. Those significant problems didn’t necessitate a financial crisis and a panic. The Fed was capable of avoiding those problems averting the crisi by adopting avoiding a misguided monetary policy focused on a non-existent threat of inflation.

    Ninth, I agree that there was a substantial misallocation of resources into finance and other socially unproductive activities. But to rebalance the economy, you don’t have to devastate it.


  27. 28 marksadowski February 12, 2014 at 10:36 am

    Peter Schaeffer,
    For the record, the increase in real corn prices from November 1971 to October 1974 took place over 35 months, which is longer than the 31 month periods to which I was confining my comparisons.

    “It is really plausible that a 0.2% of GDP change in the corn brought down the edifice of the U.S. economy?”

    It’s plausible that the refusal of the FOMC to address the rapidly worsening economic situation in the summer of 2008 was driven by their concern that rapidly rising commodity prices would cause inflation to spiral upwards.

    The US Treasury yield curve became inverted in August 2006 and stayed that way through May 2007:

    Every US recession since WW II has been preceded by an inverted yield curve in the previous 6-18 months. An inverted yield curve is strictly a matter of monetary policy choice.

    Year on year nominal GDP growth in the US fell from 6.5% in 2006Q1 to 5.3% in 2006Q3 to 4.3% in 2007Q1 to 3.1% in 2008Q1 to 2.7% in 2008Q2:

    Lehman Brothers filed for bankruptcy in 2008Q3. So the rate of change in nominal GDP had been falling significantly and steadily for two years before the financial crisis hit with full force.

    From April 30 through October 7, 2008 the FOMC kept the fed funds rate unchanged. Inflation expectations as measured by the 5-year breakeven plunged from over 2.7% in early July to less than 1.0% by late September, indicative of the extreme stress that the economy was under:

    Why didn’t the FOMC do something? Although year on year core CPI never got above 2.5% during this period, year on year headline CPI was above 5% in July through September, which was in no small part driven by the fact that year on year food inflation was above 6% in July through November:


  28. 29 Jack Rigby February 13, 2014 at 12:00 am

    Thank you peterschaeffer et al,

    As a disconnected person (at law, an officious observer) I had been quite swayed by the “Blame Ethanol” school for at least a large part of the US problems.

    As I’m forever reminding people in my own closer speciality: prestidigitation is the principal tool of Our Owners. I nearly got caught in this one.
    It is much like examining the “ClimateGate” situation, merely more complex! 🙂
    As a true supporter of the Chinese School in Economics, I do only “seek that point at which the gold comes to rest, for the truth”.
    Unfortunately, it is best used from a position of reactive power. Like the Chinese have done in Ethiopia and will do momentarily in South America.

    I will look forward to learning more of the developing situation and possible proposals for the mitigation of the “American Situation”, which is deteriorating rather more quickly than anyone expected – even the Chinese.

    This is an interesting Site to read gentlemanly opposing views. I shall be back.


  29. 30 MethaneMan February 16, 2014 at 10:26 am

    Why are we forced to burn that shit anyway – all it does is cost you more money by decreasing your mileage., thus resulting in more fuel ups. I burn Premium NO ethanol and my mileage goes up to almost 5 more miles to the gallon. My motorcycles wont run on ethanol fuel very well but purr when running premium no ethanol. And you would think that a Honda CT-90 would work well as they were designed to run on almost any type of fuel, but not ethanol. It all boils down to the mighty dollar once again, the more they can get from you the happier they are. When in reality all ethanol does is increase the amount of money you spend at the pump.


  30. 31 David Glasner February 16, 2014 at 7:16 pm

    Jack, Thanks for your comment.

    MethaneMan, Ethanol supposedly reduces air pollution. An alternative approach would be to impose additional taxes on petroleum products to reflect their environmental harm. But imposing taxes on petroleum would reduce the competitive advantage of conventional gasoline over ethanol, so the alternative policy might also result in some substitution of ethanol for gasoline. But for sure there is no justification for restricting the importation of ethanol from outside the US.


  1. 1 Odd claims that biofuels were responsible for skyrocketing commodity prices | Freewheel Burning Trackback on February 8, 2014 at 7:18 am
  2. 2 Recap of the Month’s Starred News Items from Sowing Agricultural Seeds Daily | Big Picture Agriculture Trackback on February 12, 2014 at 7:54 am
  3. 3 Exposed: Irrational Inflation-Phobia at the Fed Caused the Panic of 2008 | Uneasy Money Trackback on February 28, 2014 at 8:56 am

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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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