It is naught, it is naught, saith the buyer: but when he is gone his way, then he boasteth (Proverbs 20:14).
Every voluntary exchange involves buying and selling. The person who is called a buyer is a seller of money. He buys goods and services. The person who is called a seller is a buyer of money. He sells something of value to purchase money.
The practice described here by Solomon is familiar. In negotiating, both the buyer of goods and the buyer of money complain that the asking price is too high. It is not a good enough deal. "It is naught, it is naught." Each hopes that the seller will drop his price. In the case of the buyer of money (seller of goods), he hopes that the buyer of goods (seller of money) will decide to take less for his money. Solomon knew that his listeners and readers would recognize this negotiating technique.
The technique rests on this institutional arrangement: the right to bid. We can see this in markets in which private property is secure (the window). We also see it in markets governed by politics (the stone).
In a society with a small retail market, where there are few rival options nearby, negotiation is basic to sales. In a highly developed economy, there is not much negotiation. We do not negotiate with a check-out clerk when we get to the front of the line at a supermarket. The clerk scans the bar code on the item's package, and the computer adds it to the list of items we are buying. The negotiation rule here is clear: "Take it or leave it." It is easy to leave it. Anyone can shop at a different store, or go online to check prices.
Sellers (buyers of money) bid against sellers. Buyers (sellers of money) bid against buyers. Out of this competitive bidding process -- a gigantic auction system -- come objective prices. There is little ignorance. Face-to-face negotiating is limited to zones of ignorance regarding prices and quality. The better the information about market prices, the narrower the range for price negotiating.
There are several groups of owners, as always.
One group owns money, which is the most marketable commodity. Economists classify these people under the classification of consumers. They are sellers of money and buyers of goods to consume. In this case, the goods are food.
Another group is made up of owners of natural resources -- in this case, commodities. Economists classify natural resources under the general category of land. In this case, the land owners are farmers.
There are other owners. They own commodities, but only temporarily. They are intermediaries in between land owners and final consumers. They are producers. They purchase raw materials, labor services, and buy or rent capital in order to transform raw materials into final products. Producers are not final consumers. They are buyers, but they are also sellers. They buy in order to make a profit: buy low, sell high. They can be classified under the category of customers. In this case, they are part of the food production and distribution system. The obvious example would be a baker.
There is a fourth group: retailers. They buy goods that contain restructured commodities. They sell these to consumers. They own these commodities temporarily. A supermarket where food is sold is an example.
There is a fifth group: owners of forecasts regarding the future. They may be able to sell this information. They may choose to give it away. Until this subjective information affects actual bids in the marketplace, it is irrelevant to the pricing system. But whenever these people put their money where their forecasts are, by buying or selling commodity futures contracts, they become speculators. Their bids affect prices at the margin: up or down.
There is a biblical case of rival forecasts of the supply and demand for food. The capital city of Samaria was under siege. Food prices had skyrocketed. At this point, Elisha the prophet came before the king and predicted that the next day, food prices would be low. He was ridiculed by an officer. Elisha told the guard that he would not taste of this food. That night, the siege ended. The army fled. They left food behind. The next day, people in the city streamed out of the city to get free food. They trampled the king's officer (II Kings 6-7). In the terminology of the commodity futures market, Elisha was a "short." He expected prices to fall. The officer was a "long." He expected prices to stay high. In this case, the guard lost a lot more than money.
Because owners have the right to own, they also have the right to disown whatever they own. They can legally sell. They can legally make an exchange. This brings us to the window.
Consumers compete against consumers. Producers compete against producers. Raw materials owners compete against raw materials owners. Owners of capital compete against owners of capital. Commodity futures speculators compete against each other: "longs" vs. "shorts." Out of this bidding process comes an array of prices. The economic order in a free market system is based on a series of auctions. The same rule of exchange governs all of them: "High bid wins."
The average person knows what an auction is. He understands why the high bid wins. He understands that bidders compete against bidders. But a free market economist has a major educational task: to persuade the general public that the orderliness and fairness of an auction is a legitimate model for the entire economy. The principle of open bidding will produce an equally orderly and equally fair economy. The ability to make this application of logic -- from a local auction to an international auction -- is a limited resource. This is demonstrated by over two centuries of resistance to the the idea of free trade, which is most famously argued in Adam Smith's Wealth of Nations (1776).
The average person can easily understand and readily approve of the allocation principle of "high bid wins" at an auction. One of the tasks I have set for myself in writing this book is to help readers make the conceptual transition from "high bid wins" at a local auction to "high bid wins" for every transaction. This is more easily said than done.
In the auction markets (plural) for commodities, the principle of "high bid wins" benefits those buyers and sellers who come to an agreement on a price. There are multiple sub-markets in this and every other market. The initial market is established between commodity owners and producers. The second phase of the market is established between producers and middlemen: retailers. The final stage is the transaction between retailers and consumers. At every step, the rule is "high bid wins."
This principle of distribution annoys those who do not make the highest bid. Sometimes this annoys them so much that they form a political action group that campaigns for legislation that restricts the use of "high bid wins." People who ran out of money before the auction was over demand that the state impose legal price ceilings. But high bids come on both sides of a transaction. Sometimes those sellers of commodities who were forced to take too low a price, and who dropped out of the auction in order to avoid a loss, see an opportunity. They may be able to persuade the government to make lower bids illegal. This leads us to this chapter's stone.
Here is a major problem for economists who believe in the free market. There are few of them. They have to overcome the logic of other economists who believe in the free market for some resources, but not all. I have read a lot of economics books. I have yet to see any economics book with this title: The Free Market as an Auction. I think most economists see the market process in this way, but they rarely argue for this understanding of the market process. I do not know why this is the case, but I have my suspicions. I think they worry about this: the idea that the government should place a lid on prices at an auction is clearly ridiculous. It would destroy the auction. No auctioneers would show up. Neither would bidders. No one wants to attend a rigged auction. But if price ceilings destroy an auction, and if the free market is an auction, then there is no economic case for price ceilings. Therefore, any economist who wants to argue in favor of a price ceiling at any time prefers to avoid discussing the free market as an auction. The logic of his presentation would undermine him every time he calls for a price ceiling. No one wants to appear inconsistent. So, economists refrain from describing the free market as an auction.
Even less logical is the economist who would argue this way: "It would be beneficial to buyers if there were government controls that force the opening bid to be higher than anyone is willing to pay." This policy also would kill the auction. People come to an auction expecting bidding to begin by an initial bid. If the government were to come in and forbid low bids, and then buy the goods at a high price, prospective buyers would stop showing up. They would know that they will be outbid by the government, which can afford to outbid them. The auction is rigged.
Now let us consider agriculture. The farmers own land. They own knowledge. They own money, which they use to buy the tools of production. They own credit: their reputations for repayment of debt. They sell their crops to wholesalers, who in turn sell to manufacturers, who in turn sell to consumers. Consumers possess money. They determine, retroactively, which of the producers in this chain of service served them best. Their decisions to buy from some and not buy from others make some farmers rich and others poor.
The farmers act as economic agents of the final consumers. All of the producers do.
In the days of Solomon, every buyer and every seller had an opportunity to announce: "It is naught, it is naught." Haggling slowed down the speed of decision-making. In the modern economy, there is almost no haggling. This is because of the nature of the window: the free market's auction system reduces ignorance regarding supply and demand.
The agricultural markets have long been the most developed of markets. This is especially true of the grains. Grains are easily judged in terms of quality and type. There are professionals who make these assessments.
The free market in agricultural products is international. It is gigantic. There are hundreds of millions of farmers and billions of consumers of food. Most of these farms are small. They are in villages in China and India. They sell little food outside their villages. About three million farms feed most of the world's urban populations. In the United States, about 200,000 farms produce 80% of the agricultural output. These farmers have access to the World Wide Web. This means that price information is widespread. The food markets are international. Prices are established by competitive bidding to a fraction of any currency unit.
There is another important aspect of the grain markets: commodity futures trading. Speculators can enter these markets with a low payment of earnest money and make bids. Some of them bid to buy a large quantity of grain in the future at some price. They "go long." Others bid to deliver a large quantity of grain in the future at some price. They "go short." These speculators make a lot of money if they guess correctly about the future price of the particular grain. This opportunity for highly leveraged profits lures sophisticated forecasters into this market. The losses cull out the losers. The survivors are very good guessers.
This system of competitive bidding establishes preliminary prices for each of the grains. This price information is public. It is made available on the Web to farmers and wholesale grain buyers at no cost to them. Grain prices change, minute by minute. This means that there is a very narrow range for price negotiating. The ignorance factor is minimal. No one bothers to cry out, "It is naught, it is naught." The answer is clear: "If you can buy it cheaper somewhere, you can make a fortune with arbitrage. Buy low in one market and sell high simultaneously in another." In short, "Put your money where your mouth is." This silences most people.
Under this system of decentralized international farming, efficient farmers are rewarded. Inefficient farmers leave the field (literally). In 1800, at least 90% of the American population lived on farms. Today, this is down to 2%. American grain agriculture is the most efficient on earth. It has been since the 1840's: the reaper, the railroads, and the grasslands. About 30% of American farm income comes from exports.
With this as background, let us consider parity agricultural prices in the United States. The Agricultural Adjustment Act of 1933 established a federal loan program for farmers. Farmers could borrow money at below-market rates. They could then plant crops. In 1938, the Act was modified. Farmers who took these loans were guaranteed parity prices -- above-market prices, as it turned out. They were paid these prices for up to 75% of their output. This loan/parity price program still is in force. This reduces the participating farmers' risk of economic failure in the next planting season.
To make these government-guaranteed prices predictable, a complex formula is applied. A particular year is selected as the base year. Then the highest price paid for that crop in the base year is established as the government purchase price in the next year. If the market price falls below this price -- called a parity price -- the government buys the crop and stores it.
The special-interest farming group tries to persuade the politicians to select a base year in which there was a high price for that crop. Why not a year in which the crop sold for less? The special-interest group has an answer: "It is naught, it is naught."
Instead of letting the international markets establish the price of a crop, moment by moment, in terms of supply and demand, American politicians have intervened. A majority of them vote every year to guarantee a minimum price for most of the crops of farms that enroll in the program. If, in international markets, prices are lower than a guaranteed price, those farms that participate in the subsidy program will sell their crop to the government. They will receive an indirect subsidy from taxpayers.
One official justification for parity prices is this: these prices will guarantee that family farms will not go out of business. What has been the result? In 1930, about 25% of the U.S. population lived on farms. Today, it is 2%.
Another justification: these guaranteed prices will assure a steady, reliable source of food. The people who use this argument assume that the voters will not pay any attention to international grain markets, which are gigantic, and which have supplied a steady supply of food for over two hundred years. Except for the Irish potato famine in the 1840's, the West has never suffered a famine during peacetime.
With parity pricing, the farmers become the economic agents of the government rather than the consumers. They profit or lose in terms of prices arbitrarily established by bureaucrats, not consumers. The locus of authority shifts from fickle customers to tenured bureaucrats. Tenured bureaucrats are far easier to predict than consumers. Above the bureaucrats (at least in theory), politicians are far easier to persuade than consumers. The farm bloc has an easier time of things dealing with politicians than consumers.
First, consumers of food in the parity-price nation have a competitor in the food markets: the national government. The government can afford to buy up a large percentage of the crops in years in which prices on world markets are lower than the parity price. The crops bought by the government would have been brought to the marketplace. Sellers of crops would have competed against each other to sell all of their crops. Food prices would have been lower. But these crops are bought by the government and put into storage. This limits the supply of storage facilities, thereby raising costs.
Second, taxpayers must pay money to the government, so that the government can buy the nation's crops, or a large percentage of them, depending on the political pricing process.
In most cases, these two groups are the same. So, taxpayers are taxed so that they will have to pay higher prices for their food. They will have less money to spend, and they will have to spend more money on food.
The general public is generally unaware of all this. Otherwise, they might elect politicians who would vote against the farm-bloc politicians who vote for parity prices for agricultural products. The cry of the consumer-taxpayers would be this: "It is naught, it is naught." But they remain unaware.
Chapter 6 is "Credit Diverts Production." Parity prices and below-market interest rates on agricultural loans lure farmers into producing crops in an economy that would otherwise produce other goods and services. Consumers of food also want other things to consume. But their bids for other goods and services are reduced, first by taxes to pay for the farm bloc's surplus crops that are stored by the government or given away as foreign aid, and second by higher food prices at the supermarket. The consumers' range of choices is thereby reduced. This is another way of saying consumers are poorer than they otherwise would have been.
In the United States, where this system has prevailed ever since 1933, there has been a steady reduction in the number of family farms. Today, the percentage of the American population that is directly involved in farming is somewhere in the range of 2%. To this could be added another 13% of the population that works in industries related to agriculture.
According to recent statistics, about 97% of these farms and ranches are family-owned. But large farms that sell at least $250,000 of crops annually account for over 80% of all sales. These farms constitute about 10% of all farms. Consider what we would expect the distribution to be. The famous 20-80 Pareto curve would have estimated that 20% of the farms would produce 80% of the output. Normally, about 20% of the members of any group or industry provide about 80% of the output. This has been known ever since it was discovered by the Italian economist Vilfredo Pareto in 1897.
Why is the American agricultural production system skewed toward inequality far more narrow at the top than the Pareto curve would have predicted? The first place to look for an answer is government intervention into the farming industry. The parity system has done nothing to enable small farms to compete with large farms. If anything, the system has offered greater subsidies to large farms. The parity program is a program that subsidizes rich farmers at the expense of middle class food buyers. This has been true from the beginning.
The multibillion-dollar agribusiness industry, dominated in the United States by four companies, has used the image of the family farm to extract wealth from taxpayers and food eaters. The voters pay no attention. This is a classic example of how special-interest legislation is signed into law. Voters are not focused on how much any piece of special-interest legislation is costing them. They do not organize politically to defeat such legislation. In contrast, the richest members of a tiny economic sector -- 2% of the U.S. population -- are intensely focused on getting their legislative agenda through the political system.
There is political asymmetry here: information and motivation. The costs of organizing a decentralized voter base are very high. The risk of failure to organize them into a resistance voting bloc is also high. In contrast, the costs of organizing a tiny special-interest producers' group are low, and the benefits from a successful political campaign are high.
I would like to think that you will remember this every time you eat anything. But you won't. It would spoil your appetite. But if you say grace at meals, think of this: God's grace has been so great that it has overcome the federal government's parity price boondoggle for four gigantic multibillion-dollar agribusiness firms. You paid more for the meal than you would have paid without this boondoggle, but God in His grace, by means of an overwhelmingly free market in agricultural products, has put food on your table. Once in a while, you should pray for more grace and lower parity prices.
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