The way to fix a flawed compromise is to de-couple “negotiated” from “spot”
Senate Bill 3229, is said to be a compromise merging the 50/14 concept proposed by Sens. Chuck Grassely, R-Iowa, and Jon Tester, D-Mont., with a bill that enhances mandatory price reporting advanced by Sen. Deb Fischer, R-Neb. The original version of the 50/14 proposal would require that half of the fed cattle be purchased on the “negotiated spot” market, and Sen. Fischer’s contribution would require mandatory price reporting of all fed cattle sales, along with the publishing of a library of forward and formula contracts.
Because less than 20 percent of the fed cattle are sold on the “negotiated spot” market, which is then used to price the remaining 80 percent — this clearly results in inadequate price discovery. Absolutely! The number of “spot” market sales must be increased, and 50 percent is a good target. However, the flaw in this proposal is coupling “negotiated” with spot. A spot market is a cash market for immediate delivery. A negotiated market is one where the buyer and seller agree in private on the sale terms.
The problem in any negotiated market is that there is a built-in bias in favor of the buyer. This is because the seller has already invested their money in the cattle and have a lot to lose if the market goes down. Buyers, on the other hand, have time on their side and other cattle from which to choose. This dynamic results in a lower negotiated price than what supply and demand conditions would otherwise warrant. Economic research confirms this downward bias.
If half of the cattle are required to be sold on the negotiated spot market, this will result in lower overall cattle prices. The solution is to de-couple negotiated from spot and require instead the use of an electronic/video auction market mechanism for the spot marketing of fed cattle.
Here in cow/calf country there tends to be a distrust of auction markets. This is probably because most of us have been burned when a load of calves or culls were sold for less than they should have. As a result of these bad experiences, many ranchers prefer to market their calves by negotiating with a trusted buyer. The feeling is that not only is one avoiding the risk of a bad sale, you are also avoiding the 4 percent auction fee, along with the shrink when your calves wait three or four hours to be weighed after already being on a truck for two.
There is, therefore, a legitimate reason to prefer to negotiate rather than sending the calves to the auction barn. However, an electronic/video market overcomes many of those objections. And too, one does not really avoid the 4 percent marketing fee because the buyer with whom you negotiate also has costs that needs to be covered. The only reason that the negotiated market for feeder calves works as well as it does is because a significant number of calves are sold at the auction barns or through the electronic/video auctions. This provides an honest reference. Ultimately, the most efficient and most accurate way to arrive at optimum price discovery is through an auction. It may not be perfect, but auctions are, in the long run, better than all of the alternatives. And as an added bonus, the prices derived at a public auction are open for all to see.
In the fed cattle market, there is no honest reference, because all spot market sales are negotiated. We mitigate that to some degree by mandatory price reporting. A better solution would be to require that the spot market be conducted through an electronic/video auction where not only is price discovery more accurate, the market information is public.
Why stop there, why not require that all fed cattle be sold in an electronic/video auction. Just as in the case of the electronic/video sales for the future delivery of feeder calves, an electronic/video auction for future delivery of fed cattle would work very efficiently. As with feeder calves, where a base price is set at the time of the sale and adjusted at the time of delivery, appropriate terms can be incorporated in the contract.
We are told by the beef packers, their captive economists, and the National Cattlemen’s Beef Association that it is absolutely essential that most of the cattle be marketed through alternative marketing agreements (AMA) — better known as captive supply. Otherwise, they contend the quality of the cattle will deteriorate and consumers will stop buying beef. Maybe or maybe not, but by employing an electronic/video market mechanism, operated by an independent marketing company, packers could enter into forward delivery contracts where the base price would be adjusted at the time of delivery to compensate for actual carcass quality.
Such a market would preserve all of the alleged benefits of the current captive supply system, except that the packers would not be able to manipulate cattle prices in their favor. If the spot market sales were also reached through an electronic/video auction, the entire market for fed cattle will be open and competitive. Optimum price discovery would result.
This in turn would allow the feeder calf market to be more competitive. Instead of the current situation where the continual losses by the feeders are passed down to the cow/calf producers, actual supply and demand conditions would prevail. In 1921, they solved the monopoly problem of their day by requiring that cattle be purchased in an open and competitive forum. This requirement allowed smaller packing firms the opportunity to compete in an honest market along with full transparency of the resulting sales. It worked then, and it will work now.
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