Tuesday, January 27, 2015

Book review: "Merchants of Grain" by Dan Morgan

Merchants of Grain is a history of the international grain trade, with an emphasis on the five companies that dominated it during the 1970s: Andre, Bunge, Cargill, Continental, and Louis-Dreyfus. Archer Daniels Midland figures much less prominently, probably because their business was concentrated in the United States.

The book begins in ancient times: Classical Greece wasn't self-sufficient in food production, and this was the genesis of the first global grain trade. Athens imported grain from Egypt and the Near East through a proto-modern system of shipowners, bankers, and merchants. Likewise, the Roman Empire required large imports of Egyptian and North African grain to feed its capital city.

Grain trading was much less prominent in medieval and renaissance Europe, most of which didn't enjoy the cheap seaborne transportation that Greece and Rome had enjoyed. In the 17th century, only 3% of Europe's wheat harvest crossed national borders. The modern grain trade began in the 19th century, with the Industrial Revolution and the mass migration of people to cities.

One of the major trade routes that emerged transported Russian wheat from Odessa to various Western European ports. Greek shippers dominated this route in its early decades, but they were eventually muscled out by British and French traders who enjoyed support from their governments and domestic banks. Later the British grain traders themselves faded from prominence, in part because British millers began to contract grain purchases directly. Even as harvests and shipments grew exponentially, the industry had many losers.

The United States became a major grain exporter when the Great Plains were settled. An American milling industry sprang up, concentrated in Minneapolis, and the grain trade emerged alongside it.

Merchants of Grain suggests that grain processing and trading was more profitable in the past than it is today. Minneapolis's two major grain terminals had 30-40% returns on equity in the 1880s. (The book implies that the high ROEs were a result of anti-competitive practices that would be illegal today.) In 1920, the Federal Trade Commission investigated the trading companies that exported American grain and found that they had an aggregate return on assets of 22% and an aggregate return on equity of more than 40%.

The high returns ended during the Great Depression, which put many grain traders out of business, but the ones who survived participated in another boom after World War II. The book states that "Only a few million tons of grain a year moved down the Mississippi River immediately after World War II. By 1975, nearly 50 million tons of corn, soybeans, and wheat traveled down this river artery."

Starting in 1972, the Soviet Union began importing large quantities of grain from the U.S. in response to poor harvests. This caused wheat, corn, and soy prices to surge. (The book doesn't state whether the Soviet imports were the main reason for this or a catalyst for underlying inflationary pressures-- I suspect the latter.) The price surge had various effects:

• Farmers could make more money selling grain than feeding their livestock, so they slaughtered them at abnormally high rates. This led to large glut of pork at first, then a shortage and surging prices.

• Commodities trading exploded. The large grain traders conducted most of their business through a private grain exchange because the public commodities exchanges were too small to handle all of their business. Nonetheless, "A seat on the Chicago Board of Trade, which had gone for $20,000 in 1960, cost more than $150,000 in 1976, exceeding the price of a seat on the New York Stock Exchange."

• Commodities trading profits exploded as well. "In 1971-72, Cargill's earnings after tax were $19.4 million. The next fiscal year they jumped to $150 million. Worldwide the company earned $886 million after taxes between 1970 and 1976."

In retrospect, this was a once-in-a-century boom in an otherwise-mediocre industry. The book mentions that the grain traders had poor returns in the 1960s, prompting them to diversify into shipping, meatpacking, and oil. Returns worsened again in the late '70s, and there were several blowups. A rapidly-growing grain trader called Cook Industries went out of business after shorting soybeans while the Hunt Brothers tried to corner the market, and Continental short-sold the Soviet Union a large quantity of grain right before prices surged.

Poor returns and blowups seem to have become the norm since then. Andre went bankrupt in 2001 after a rogue trader lost $200mm on soybeans. It had lost money for a couple of years before that, and the rogue-trading loss pushed it over the edge. Continental, which processed a quarter of America's grain during the 1970s, exited the industry in 1998 and is now exclusively a meatpacker.

Miscellaneous things

Wheat varies a lot in protein content, and high-protein and low-protein wheat are used to bake different things. Typically high-protein wheat sells at a premium. Drought increases protein content, and Western Canada tends to produce higher-protein wheat than the Great Plains.

In the late 1800s, Russian wheat developed a reputation for being low-quality: exporters tried to increase their profits by diluting the wheat with rocks, soil, etc. Some British importers responded by investing in machinery that would clean the grain. It reminds me of oil refineries that are optimized to process high-sulfur oil.

California experienced an agricultural boom after the gold rush ended. For a couple decades it was a major grain exporter to Britain until British colonies-- particularly India-- displaced it in the 1880s.

The book mentions numerous grain traders who went bust after initially making big profits, including Jospeh Leiter, Isaac Friedlander, Mark Najar, and Ned Cook. Friedlander went broke a few times.

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