The fundamentals of fungibility – Twin Cities

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

Edward Lotterman

This is happening now that trade in grains, oilseeds, energy products and non-ferrous metals is physically prohibited by the fighting in Ukraine and the resulting economic sanctions against Russia. Such interruptions to normal trade and finance certainly affect households and businesses in European countries close to war, especially Finland, Poland and Germany. They also affect people in our country and can strike families in places as remote and totally uninvolved as Zaire, Myanmar or Bolivia.

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

However, the effects vary from product to product. This is true in international trade disruptions, including the trade wars of choice that President Donald Trump started early on. It is therefore useful to examine the causes of the differential impacts on the prices of commodities such as natural gas, crude oil and refined gasoline, cheese, chicken and soybeans.

Start with the degrees to which goods are “fungible commodities”. It is the extent to which one unit of good from one source can replace another from other sources.

Number 2 yellow corn, 87 octane unleaded gasoline, refined white sugar, and 12% protein all-purpose wheat flour are all extremely fungible. It doesn’t matter if the gasoline for my car comes from a refinery in Minnesota, Texas, Alberta or Saudi Arabia. Yellow corn can come from Mower County, Minnesota, 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 ground and mixed from hard red spring wheat from the Red River Valley or winter wheat from Oklahoma, Argentina or Ukraine, it works great in my pies and my bread. Either way, you would need a fairly sophisticated lab to find the differences.

Other items we find in the store are not very fungible. Gouda cheese from the Netherlands and Colby from Pine Island, Minnesota can be marketed internationally, but taste different. Ditto for raw materials that we don’t see, but are used in the production chain: heavy sour crude oil from Venezuela versus light, sweet crude oil 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 remember in 1982 telling a Peruvian agronomist that his country would never succeed as an asparagus exporter. Now we often eat Peruvian asparagus and cannot distinguish it from those grown in California or Mexico. Everything is fungible for consumers.

Fungibility also relates to available substitutes. Asparagus isn’t cauliflower or Green Giant Niblett’s, but if people can’t get one vegetable out of so many, it doesn’t annoy them as much as gas going up a dime. If Thai rice exports were stopped, North Americans might eat more potatoes or pasta. It would be more difficult for rice importing countries in Asia.

In addition to fungibility, there is transportability and storage capacity. Crude oil is cheap to transport over long distances. Pipelines are a familiar technology everywhere, as are tankers and storage tanks. Natural gas can also be transported over long distances inexpensively in pipelines. But because it must be compressed and liquefied, shipping it between continents and storing it in reservoirs is much more difficult and expensive than crude or refined oil.

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

Thus, the more a commodity is fungible, transportable and storable, the less the disturbances of prices and world markets due to wars or natural disasters are felt. Yet these same factors ensure that the effects, however mild, can spread around the world, even to countries that never import a bit from directly affected sources.

Crude oil is not perfectly fungible like soybeans, but fungible enough that Russian export cuts affect fuel prices around the world. The sizes will not be identical, but no one will escape it. Transportation and storage difficulties mean that a Russian cut in natural gas exports would hit Western Europe, particularly Germany, hard. There is some regional production and pipelines from Algeria, but adjustments would be difficult. As everywhere with all goods, adjustments are more difficult in the short term than in the long term.

A related issue is the effects of trade embargoes on export producers rather than consumers.

Soy is a good example. In 2016, Trump exposed the treachery of China’s trade surpluses with us. Very early as president, he unilaterally ended NAFTA and restricted imports from China. China retaliated by restricting imports from us, including agricultural products, especially soybeans.

Experts said grim and catastrophic for American farmers. A Purdue AG economist predicted that US soybean growers would face 30% lower prices while Brazilians prosper. I knew him and respected him deeply, but his prediction was disconcerting. Soy is highly fungible, easy to transport and cheap to store. Markets are very efficient. Producers, traders and users can hedge risk 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?

He does not have. A dataset comparing Chicago spot prices to Brazil’s from 2006 to 2022 shows that price relationships, which are very close, did not change at all before or after the start of the US-China trade war . Corn data appear similar. Yet the U.S. Treasury paid $28 billion in special payments, known as “Trump kickbacks,” in my hometown to compensate U.S. farmers for phantom losses due to Chinese perfidy.

When war or natural disaster destroys production or halts long-term exports, as Russia is trying to do with Ukraine, and as the United States and Europe are trying to do with Russia, Price effects for producers and consumers around the world will be greater than a trade war between two countries. Russia’s invasion of Ukraine will increase global food prices and, to the extent that overall Russian oil exports are reduced, will similarly increase fuel prices. But in any case, the fungibility of the product concerned will be an important factor.

St. Paul economist and writer Edward Lotterman can be reached at stpaul@edlotterman.com.

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