Speculation and Food Prices

Oct 16, 2011 Editorial

Today, ”World Food Day”, is being commemorated under the theme ‘Food Prices- from Crisis to Stability’. On Saturday we reported the remarks of the Food and Agriculture Organization (FAO), Country Representative that increased demand from emerging countries as a driver of escalating prices is wreaking havoc on the lives of the poor.
She called on our government to provide safety nets and food reserves. Unfortunately, she missed the major culprits precipitating the crisis.
Among the possible causes economists have put forward for the food price volatility were drought, meat-intensive dietary habits and market hypersensitivity to supply and demand. Another was corn-based biofuel: In less than a decade, some 15 percent of the world’s corn production has been converted from food to fuel. But perhaps most controversially, some economists blamed a flood of speculators betting on the rise or fall of food prices.
A new analysis, by New England Complex Systems Institute (NECS), seems to have resolved the issue and puts the blame squarely on biofuel policy and mortgage-meltdown-style speculation, which may have fundamentally changed how food markets function. Speculating on food isn’t new, but it was long restricted to farmers and companies involved in food production.
For them, speculation was a classic form of hedging: A farmer could, for example, make a bet that crop prices would fall. If they didn’t, he’d benefit from his harvest’s high prices; but if they did fall, winning his bet would offset the losses. Speculation was, on the whole, a stabilizing force.
In the late 1990s, however, a financial industry-led push for deregulation in the US – which eventually would lead to the 2008 mortgage meltdown — changed how food speculation worked. Anyone could participate. Bets on food were suddenly made by investment companies who could package and repackage their bets into the sorts of derivatives made famous by the mortgage crisis.
According to some economists, this disconnected food prices from basic laws of supply and demand, and made them prone to wild swings. But others disagreed, saying the mathematical signs of cause-and-effect were hazy or absent.
NECS approached this morass of “explanations” with a series of mathematical models designed to simulate the trend-following investment behaviour of speculators and food producers. Key to their models was a link between food prices among speculators and the so-called spot price of food at markets where actual commodities, not their hypothetical future values, are traded.
Some critics of the proposed speculation-food bubble link assert spot prices are established independently, from moment to moment, in isolation from any speculative influence. But when NECS contacted people in the business, at granaries and the U.S. Department of Agriculture, they were told that spot prices are set in reference to the futures market at the Chicago Board Options Exchange.
With the link to speculation established, the researchers let their model run. What resulted was a pattern of month-to-month prices similar to the peaks and valleys seen in real-world food price fluctuations since 2007. However, speculation didn’t replicate the observed long-term, year-to-year rise in food prices. Those only appeared when the NRCS team added the shift of corn from use as food to use in ethanol biofuels.
With both speculation and biofuels included, the model produced a series of food prices uncannily similar to recent history.
While slowly rising prices are a problem, however, the rapid short-term bursts are more troubling. In the last decade, those bursts occurred only after 2007, a time when investors moved money en masse into commodities. That timing fits with another finding of NECS model: Some speculation is fine, even beneficial, but too much makes a market prone to instability.
It is now up to the governments where the markets for food futures operate to instil some sort of regulation akin to the ones seen as necessary for the financial markets not to bring down the entire economy. Our dilemma in Guyana, both for our farmers and our consumers is that when the elephants up north fight or make love, we the grass get flattened.

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