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February 11, 1977 Black Magic The first known coffee advertisement in 1652 claimed that coffee "quickens the spirits and makes the heart lightsome, . . . is good against sore eyes, . . . excellent to prevent and cure the dropsy, gout, and scurvy." While medical research has not borne out the full range of these claims, and has, in fact, even discovered some unwelcome sideeffects of the delectable beverage, there is something about coffee that keeps people buying and drinking it no matter what the price. In technical terms, its demand is price inelastic-when the price of coffee goes up by a given percentage, consumers' purchases will decline by something less than the percentage increase in price. Specifically, when retail coffee prices rise by 10 percent, purchases tend to fall by only 2 to 4 percent. JavaMan in Rio But coffee prices have risen by much more than 10 percent recently. In fact, since the Brazilian freeze of 18 months ago, prices of the basic raw material (green coffee) have risen in New York by a massive 255 percent. But sharp price fluctuations are not unusual for this commodity. With sharp changes in production, coffee prices tend to run in roughly 20-year cycles. The last cycle began its upswing in the late 1940's, peaked in the mid 1950's and continued downward until 1972. No one need guess where we are today. Governments in producing countries can take actions to stabilize prices, but the game is a tricky and potentially expensive one. Brazil found this out in the 1930's, when its attempts to stabilize prices led it to burn some 80 million bags of coffee, equivalent to two full years of world consumption. Its actions were understandable, however, in the light of an old rule of thumb which says that unilateral action by a producing country (such as holding crops off the market) can be successful if its share of the total market exceeds the price elasticity of demand for the relevant commodity. Brazil could benefit from unilateral action around the turn of the century, since it then produced 70 percent of the world's coffee-in other words, its market share of .7 exceeded the price elasticity of .2 to .4. However, as other Latin can and African countries joined the coffee game, Brazil's market share slid back to the present figure of 30 percent, so that it now has less freedom of action than heretofore. Petrcolating prices Before 1950, the wholesale price of green coffee generally fluctuated between a nickel and a quarter per pound, with the last super-low prices being in the six-to-sevencent range in 1940. Last week, green Brazilian coffee was going for $2.25 a pound in New York. The basic' reason was the chilly night of July 17, 1 975-a night that will live in infamy-when an unwelcome Brazilian frost not only devastated the current crop, but also destroyed a large portion of the coffee trees themselves. The Braz'ilian crop fell (continued on page 2) from 28 million to about 11 million (60 kilogram) bags}according to U.S.Department of Agriculture estimates.Very dry conditions in early 1976reduced the crop further to 9.5 million bags(USDAestimates) or as little as6 million bags(Brazilian estimates).Production hasheld up remarkably well elsewhere}despite weather problems and civil strife in other producing areas.But in the aggregate}Brazil'ssevere decline has more than offset an increasein non-Brazilian production} leading to a 1976/77 world crop of 64.7million bags-about a 14.6-percentdecline from a year ago. Dll'ipgB'ind While such a production decline should certainly be accompanied by some rise in prices}there is still a question why prices have risen as fast asthey have. A recent estimate of the price elasticity for green coffee pegsit at about -0.32.Other things equal} a decline in production of 14.6percent thus would be accompaniedby a price increaseof about 46 percent. Of course other things are not equal. Incomesand prices generally have risen in consuming nations, and certain market factors (suchasdeclining stocksand rising export taxes)hav.efurther pushed green coffee prices upward. Making generousadjustments for these factors yields an estimated price increaseof about 130 percent since the freezeconsiderably lessthan the 255percent rise actually encountered. 2 Why the difference? First the villain theory. Admittedly} Brazil hasmade purchasesof about 900}OOObagsof coffee from EI Salvadorand the MalagasyRepublic} tending to boost prices even more, but much of this coffee was later repurchased by EI Salvadorwhen it realized that its own quota under the International Coffee Agreement could be reduced by virtue of the Brazilian sale.Also} Brazil no longer has a large enough market shareto be able to raise its own income through a unilateral reduction in world supply. Only if all the major coffee producers}acting in unison, withheld coffee from the market could all countries benefit from a price rise. And unlike the caseof oil} there has been no evidence of any overt cartel-like activity. A second possibleexplanation is the inventory situation. After declining for a decade}coffee inventories could be very low by the end of this year. While there is no actual shortagetoday-i.e.} production plus inventories can fill traditional consumption requirements-two more yearsof low Brazilianproduction could pretty well deplete world stocksand lead to an actual Somewholesalersand retailers (and consumers)may be building up their own stocksin anticipation of such a shortage}and their actions would give an additional boost to current prices. (The extent of those buying pressures would be hard to evaluate)however.) Yet on balance}green-coffee prices are definitely higher than one would expect given basicsupply and demand factors. Indeed} we may note that the futures market has been pricing future deliveries of coffee at lessthan current prices. Drink more milk The immediate future is not bright for the consumer.Though greencoffee prices are unlikely to rise any further (barring any further weather or diseasedamage);the previous price escalationhasyet to work its way through the system.Sincethe July 1975freeze, green-coffee prices have risen by 255percent, but wholesale prices by only 117 percent and retail prices by a meager 88 percent. Wholesale prices shouId not rise as much as greencoffee prices,sincethe pricesof the labor, metal, energy and other factors which combine with the green coffee to make tinned, ground coffee have risen relatively slowly over the past18 months. But even if wholesale prices now froze in their tracks, retail prices probably would continue to rise. In SanFrancisco,for example, a m'ajor brand of coffee is currently wholesalingfor $3.08a pound and retailing for only $2.59.When supermarkets replenish their stockswith the more expensivestuff and add on their usual14-percent margins, consumerscould be paying $3.51a pound. (Averagegrocery mark-ups are about 19 percent, but coffee, the traditional loss leader, normally carriesa lower margin.) What can consumersdo? Retire Danny Thomasand Joe DiMaggio? Boycott the habit-forming drug? A serious boycott with, say,a 30-50 percent decline in consumption would bring prices down-at least for the duration of the boycott. 3 However, the beneficiariesof the low prices would be the addicts who kept right on drinking, while assoon as the boycott wasover, prices would begin to rise again. Besides,it would take a heroic effort to marshala large boycott againstcoffee. Compare the situation with the sugarepisode of 1974. When sugar prices soared in that year, food processorsswitched to corn sweetenersand consumersto honey. But only a few consumers will eagerly switch from coffee to even its distant caffeine cousinstea and cola. And cocoa, another possiblealternative, hasits own problems right now. Coffee, indeed, has no very close substitutes.This does not mean that consumerswill not drink lesswhen prices rise-our price elasticity estimatesshow that they will. In 1954, when retail coffee prices climbed 43 percent in 18 months' time, consumersbegan to squeezean additional 20 cups from each pound of coffee. Still, it is doubtful that coffee drinkers will now allow their brew to be much diluted beyond its present60 cups per pound. So, the scenariofor the rest of 1977 might look like this: no further rise in green-coffee prices,a relatively modestrise in wholesaleprices,and perhapsanother 40-percent climb in retail coffee prices.The boycott may not be very effective, though per capita consumption of coffee should continue to decline as it has for the past decade and a half. Michael Gorham uo:).8u!4SEM. 4Eln • uo8al O • EpE/\aN .04E PI !!EMEH .. E!UlO}!I EJ EUOZPV lDISEIV II 0 \lIT\]]<£) 'me;) 'O:JSPUl2. Dj (;S.l 'ON m Vd lUTeS llW5J1@[p)@ 's'n lBVW SSV1::> B AN KI N G D ATA- TWl ELfTH lFlEDlERALlRlESlERVlE Selected Assets and liabilities large Commercial Banks Amount Outstanding 1/26/77 Loans (gross, adjusted) and investments* Loans (gross, adjusted)-total Security loans Commercial and industrial Real estate Consumer instalment U.S. Treasury securities Other securities Deposits (less cash items)-total* Demand deposits (adjusted) U.S. Government deposits Time deposits-total* States and political subdivisions Savings deposits Other time deposits:j: Large negotiable CD's 92,092 69,761 1,273 22,686 21,750 12,336 9,386 12,945 91,759 25,655 389 64,467 5,929 30,870 25,620 9,438 Weekly Averages of Daily Figures Week ended Member Bank Reserve Position ExcessReserves (+)/Deficiency H Borrowings Net free(+)/Net borrowed H Federal Funds-Seven Large Banks Interbank Federal fund transactions Net purchases (+)/Net sales H Transactions with u.S. security dealers Net loans (+)/Net borrowings H 1/19/77 + + + - - 1/26/77 + Change from 673 450 224 190 43 42 225 2 1,418 654 204 518 19 3 284 507 Change from year ago Dollar Percent + + + + + + + + + + + 4.86 + 7.55 + 63.00 - 3.02 + 10.64 + 15.59 9.45 + 2.81 + 4.03 + 7.85 - 25.05 + 2.77 - 20.99 + 29.99 10.03 - 31.89 4,271 4,897 492 706 2,092 1,664 980 354 3,554 1,868 130 1,735 1,575 7,122 2,856 4,419 Week ended 1/19177 Comparable year-ago period + + 64 8 56 51 3 54 + 688 + 1,263 + 1,291 + 188 + + 351 + 33 5 28 234 *Includes items not shown separately. :j:lndividuals, partnerships and corporations. Editorial comments may be addressed to the editor (William Burke) or to the author . . . . Information on this and other publications can be obtained by calling or writing the Public Information Section, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 94120•. Phone (415) 544-2184.
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