Published on August 17, 2009
“Virtual Global Food Reserve Policy to Protect the Poor and Prevent Market Failure" Joachim von Braun and Máximo Torero IFPRI Presentation at USDA 22nd of October 2008
Sources and features of the food crisis 1. Income and population growth 2. Energy and biofuels 3. Slow agricultural supply response 4. Market and trade policy 5. Speculation and market fundamentals
Ad hoc trade measures add up to policy failures • Export bans/restrictions: - Reduce global market size, increase volatility, and harm import-dependent trading partners - Stimulate cartel formation, undermine trust, and encourage protectionism • Price controls: - Reduce farmers’ incentives to produce more food - Divert resources away from those who need them most
Speculation: a symptom and a source ? • Low stock levels and ill-designed policies promote speculation • Main categories of speculators: - Governments - farmers, households, small traders - Commercial traders - Non-commercial traders
What food crisis? • Political destabilization • Macro-economic / inflation • Poverty and hunger
The food crisis tradeoffs Energy security Political security risks risks Food security risks + Mass protests in more than 60 countries + Inflation and macro-economic imbalances + Environmental sustainability consequences
Food putting pressure on overall inflation China, y-o-y India, wholesale 25 4 Overall Overall 20 Food Food 2 15 10 0 5 0 -2 Jan-05 Jan-06 Jan-07 Jan-08 Jan-05 Jan-06 Jan-07 Jan-08 Ethiopia Mexico 6 Overall 4 Overall 4 Food Food 2 2 0 0 -2 -2 Jan-05 Jan-06 Jan-07 Jan-08 Jan-05 Jan-06 Jan-07 Jan-08 Source: Data from government statistics.
Surge in cereal and oil prices 900 140 800 Maíz 120 Corn 700 Arroz Rice 100 600 500 Trigo Wheat 80 400 Petroleo (escala derecha) Oil (right scale) 60 300 40 200 20 100 0 0 Sources: FAO 2008 y IMF 2008
IFPRI’s scenarios [Models for changes in structural supply and demand factors (2000-05 and 2006-15)] US$/ton 300 200 100 0 2000 2005 2010 2015 Rice Wheat Maize Oilseeds Soybean Source: M. Rosegrant (prelim. results with IMPACT-WATER).
The spike is not explained by fundamentals 900 140 800 Maíz 120 Corn 700 Arroz Rice 100 600 500 Trigo Wheat 80 400 Petroleo (escala derecha) Oil (right scale) 60 300 40 200 20 100 0 0 Sources: FAO 2008 y IMF 2008
Two explanations for the spike Explanation 1: Export bans and restrictions • Because of highly concentrated markets • Simulations based on MIRAGE model showed that this explains around 30% of the increase of prices in basic cereals Explanation 2: Speculation in the futures markets • Significant increase of volume of globally traded grain futures & options • Governments increasingly curb hoarding (e.g. India, Pakistan, Philippines) • Non-commercial share in future transactions increase • etc
Does speculation explain the spike in the first six months of 2008? • Changes in supply and demand fundamentals cannot fully explain the spike in food • Rising expectations, speculation, hoarding and “hysteria” are among the additional factors • The flow of speculative capital from financial investors into agricultural commodity markets has been drastic. • In 2007, volume of globally traded grain futures & options increased by 33 & 48% (Chicago Board of Trade) • By May 2008, the volume of globally traded grain futures and options increased significantly compared to the same period in 2007.
Numeber of contracts for Wheat, soybean, and corn(Millions) 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 Jan-02 Apr-02 Jul-02 Source: CBOT Oct-02 Jan-03 Apr-03 1 contract = 5,000 bushels Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Wheat Jul-05 Rough Rice Oct-05 SOURCE: U.S. Commodity Futures Trading Commission Jan-06 Apr-06 Jul-06 Corn Wheat Oct-06 Jan-07 Apr-07 a. Increase in volume Jul-07 Corn Oct-07 Jan-08 Soybeans Apr-08 0 10 20 30 40 50 60 70 Number of contracts for Rough Rice (Thousands)
b. Open interest index SOURCE: U.S. Commodity Futures Trading Commission
c. Future contracts: ratio volume to open interest (monthly volume / monthly open interest) SOURCE: U.S. Commodity Futures Trading Commission
d. Non commercial traders SOURCE: U.S. Commodity Futures Trading Commission COMMODITY: CORN - CHICAGO BOARD OF TRADE; 5,000 BUSHELS (contract code 2602) Description: the graph shows the total number of long/short positions by non-commercial traders as a fraction (vertical axis) of the total reportable long positions (commercial + non-commercial)
e. Evidence of causality Commodity Indicator of speculation activity Wheat Corn Soybeans Rice 1. Monthly volume (futures contracts CBOT) 2. Monthly open interest (futures contracts CBOT) 3. Ratio volume to open interest (1)/(2) (futures + + contracts) (Apr/05 - (Dec/04 - Oct/07) Jun/07) 4. Ratio non-commercial positions to total reportable + positions (long) (Sep/05- Mar/08 ) 5. Ratio non-commercial positions to total reportable + + positions (short) (Jan/05- (Aug/05- Jul/07) Feb/08) 6. Index traders net positions (long – short positions)* + N/A (Jan/06 – May/08) - “+”: evidence of causality - Starting period of evidence of causality in parenthesis - * It combines futures and options positions, data available since January 2006. Source: von Braun, Robles, Torero (2008)
Why is it important to avoid speculation? • Spikes in prices of 3 months or more could have severe effects over poor and their nutrition with long term effects => food security risks • Mass protests in more than 50 countries has shown that the poorest suffer most and do so silently => political security risks • Could create inflation and macro-economic imbalances
What to do? • Should physical, public, globally managed grain reserved be developed? Answer: NO Why: a. high storage costs b. slow transactions. c. Will create more pressure of the demand
What to do? • Should we reform commodity exchanges by: • limiting the volume of speculation relative to hedging through regulation; • making delivery on contracts or portions of contracts compulsory; and/or • imposing additional capital deposit requirements on futures transactions. Answer: probably NO Why: a. Difficulties in walking a line between ineffective regulators and overzealous ones. b. Market regulation also raises political economy concerns (lack of institutional capacity, some groups benefited over others)
What we propose A New Global Institutional Arrangement This arrangement consist of two prongs: • A minimum physical grain reserve for humanitarian assistance, and • A virtual reserve and intervention mechanism to calm markets under speculative situations, backed up by a financial fund.
Prong 1: An independent emergency reserve • A modest emergency reserve of around 300,000 metric tons of basic grains—about 5 percent of the current food aid flows of 6.7 million wheat-equivalent metric (responsibility G8+5 • This decentralized reserve would be located at strategic points near or in major developing-country regions, using existing national storage facilities. • The reserve, to be used exclusively for emergency responses and humanitarian assistance, would be managed by the WFP and factored into a new Food Aid Convention
Prong 2: A virtual global food commodity exchange • A coordinated commitment by the group of participating countries. Each of the countries would commit to supplying funds if needed for intervention in grain markets • Determining the size of this fund will require further analysis as commodity futures markets allow for high levels of leverage. For example, a fund of US$12 to 20 billion might cover 30 to 50 percent of normal grain trade volume • These resources would be promissory, or virtual, not actual budget expenditures.
How the virtual reserves will work • The intervention will take place in the futures market => A signal of a potential intervention will be announced • Intervention will happen when the “global intelligence unit” triggers the alarm that prices are significantly above their estimated dynamic price band based on market fundamentals • The intervention would consist of executing a number of silent short sells over a specific period of time in futures markets around the world at a price lower than the current future price. • The global intelligence unit would recommend the price or series of prices to be offered in the short sales
Why it will work • The increase in the supply of future sells (short) should lower spot prices and minimize speculative attacks - If there is a response it will imply that speculators will have to ask for a higher price which will imply a profit for the virtual reserve - If there is a response with a lower price then the reserve will loose money but prices will be even lower • The virtual fund will come into play only if there is a need to realize the future sells • Usually, this action would not be necessary and the whole operation would stay virtual.
Evidence that future prices could affect spot prices • McKinnon; (1967). Futures markets, buffer stocks, and income stability for primary producers. JPE, 75 (6), pp. 844-861 • McKinnon; (1971). Futures markets and buffer stocks: a reply to William Poole. JPE, 79(2), pp. 351-355 • Turnovsky; (1983). The determination of spot and futures prices with storable commodities. Econometrica, 51(5), pp.1363-1387. • Crain S and Lee J; (1996). Volatility in wheat spot and futures markets, 1950-1993: Government farm programs, seasonality, and causality. The Journal of Finance, 51(1), pp. 325-343. • Gilbert; (1983). Futures trading and the welfare evaluation of commodity price stabilization. The Economic Journal, 95(379),pp. 637-661. • Kawai; (1983). Price volatility of storable commodities under rational expectations in spot and future markets. International Economic Review, 24(2), pp. 435-459 • etc
What is the institutional design behind the reserves Intelligence unit • Model fundamentals • Model dynamic Futures market price band • Trigger alarm High level technical commission • Approve intervention delivery occurs in less than 2 percent of all agricultural contracts traded Backwardation should happen Country Appoint commitment to supplying funds
Final remarks 1. Poor can not afford speculation 2. Governments can’t afford speculation 3. There is clearly a need to regulate the basic grains futures commodity market 4. A virtual reserve is an option which is mostly a signal which could avoid speculators coming in to this market 5. If speculators get the signal this would become real regulation - minimizing the costs to the poor
What could be expected? • Food price stabilization • Access to food supplies at reasonable and stable prices in times of crisis • Calm food markets and price speculation containment • Comprehensive Cost / Benefit assessment must go beyond agricultural markets (incl. security and poverty considerations)
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