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The Globe and Mail

The global implications of North America’s drought

A corn field affected by drought near Paris, Missouri, on July 13, 2012.

Adrees Latif/Reuters

Drought conditions have resulted in a dire environment for the North American corn and grain crops, and widespread repercussions are already apparent in economic data releases. On July 13, a surprise jump in U.S. producer prices was attributed to a 0.5 per cent month-over-month spike in food costs, a definitive sign that rising corn prices were negatively affecting U.S. economic activity.

The benchmark North America corn price has shown dramatic appreciation in recent weeks, climbing 52 per cent from June 5 lows. Recent estimates indicate that the current drought, in terms of the percentage of farmland affected, rivals the Dustbowl year of 1934 and represents the worst crop conditions since 1988.

The economic effects of rising grain prices will be most obvious in the consumer price index. In driving CPI higher, rising food costs will reduce disposable income and squelch some of the retail spending-related optimism generated by the recent climb in consumer credit. In addition, U.S. gasoline prices are likely to climb as the rising costs of ethanol production are passed through to consumers.

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The effects of higher corn and wheat prices will also have negative impacts on corporate profits. Gasoline prices will affect transportation stocks and grain costs will undoubtedly affect profits for food and beverage companies which, in many cases, have seen their stocks outperform the market to date in 2012.

The impact of continued high grain prices will also be felt globally. China is already the world's largest importer of soy and the government recently announced plans to increase corn imports by 40 per cent. China's efforts to control inflation, particularly food costs, have been well documented but rising grain prices have the potential to intensify this initiative.

Grain traders are historically prone to frequent bouts of hysteria and investors should keep in mind that two weeks of wet weather could improve crop yield forecasts dramatically. If, however, drought conditions continue, the aftershocks will be felt throughout not only the North American economy, but global economies as well.

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