Severe heat and drought in the American Midwest have seriously damaged the maturing corn crop, triggering yet another food price panic. Ever since the memorable food price spike of 2008, it hasn't taken much of a drought in any grain-growing region to rattle the market. Two years ago it was a drought in Russia. Last year it was a near-drought in China's northern wheat belt. Now we have hot and dry weather in the US corn belt.

Because of very little rain over the past six weeks, roughly 30 percent of the entire corn crop in the United States is now rated in "poor" condition, compared to just 9 percent in poor condition at the same time last year. If rains do not fall soon, the damage will increase. The US Department of Agriculture has now cut the projected size of this year's crop by 12 percent from its optimistic June projection, and in the last six weeks corn prices have increased 33 percent. The US is the source of roughly 60 percent of all corn exports, so the higher prices are radiating outward. China is increasing its corn imports this year, and was lucky to have made at least one round of US purchases in May, when the price was still low.

Soybeans are another worry. China currently depends on the world market for nearly 60 percent of its total soybean requirements, and about 40 percent of these imports have recently come from the US. Because the US soybean crop is also under drought and heat stress, future prices for soybeans have been rising, up to $15.29 per bushel for November delivery. Buyers in China are now absorbing this price hit, and speculators on the Dalian exchange are reacting to the drama.

Rather than panic, traders and policymakers in China should take a deep breath and consider the larger picture. There is still time to save most of the US' soybean crop if rainfall patterns return to normal. The corn crop has already been seriously damaged, but not beyond any recent historical experience. A severe drought in the American Midwest in 1988 cut the corn harvest by 31 percent, and even then we all survived. Currently 40 percent of the US corn crop is still in good to excellent condition, whereas in 1988 at this point only 23 percent of the crop was in good to excellent condition.

We also have a cushion, because many more acres in the US have been planted with corn this year. With more acres in corn, a drop in yield per acre is easier for markets to absorb. In fact, even with drought damage taken into account, the US Department of Agriculture is projecting a final crop of 329.4 million tons, the second largest US corn crop ever. Corn production in the European Union and Canada will actually be up from last year, so world production is projected at 905.2 million metric tons, an all time record. World food markets are fairly well stocked, because last year's global grain harvest for all crops was nearly 7 percent higher than the previous year. This is one reason the international FAO Food Price Index has recently been declining and is now 15 percent below the February 2011 peak.

Another reassuring factor has been falling energy prices, down 25 percent since March. These lower energy prices have helped contain a run-up in corn prices because they reduce the incentive to divert corn into the production of ethanol for use in automobile fuel. Roughly 23 percent of all US corn production is diverted to produce ethanol for auto fuel nowadays. The combination of falling energy prices and higher corn prices makes this use of corn far less profitable, so ethanol makers in the US are purchasing less corn, and quite a few are even idling their plants.

Unfortunately, there is a limit to this form of "drought relief" for consumers, because a Renewable Fuel Standard law in the US mandates a minimum quantity of corn-based ethanol production every year, regardless of price relationships. In the 2012-13 corn marketing year, an astonishing minimum of 100 million tons of corn will have to be used for fuel to meet this legal requirement. One good way to blunt a spike in corn prices would be to relax this inflexible mandate. Some in Congress tried to do so in 2011 without success, but the Environmental Protection Agency does have authority to grant a temporary waiver from the mandate at any time if it is "severely harming the economy of a state, a region, or the United States".

US officials have long scolded China for not letting markets work, and for trying to run too much of their modern economy through state targets and inflexible mandates. The damage done by the US' ethanol mandate in the context of today's Midwest drought gives Chinese officials a chance to tell their counterparts from the US, "Practice what you preach".

The author is a professor of political science and public policy at Wellesley College and at the Harvard Kennedy School of Government.

(China Daily 07/20/2012 page9)