“Virtual Global Food Reserve Policy
to Protect the Poor and
Prevent Market Failure"
Joachim von Braun and Máximo Torero
IF...
Sources and features of the food crisis
1. Income and population growth
2. Energy and biofuels
3. Slow agricultural supply...
Ad hoc trade measures add up to policy
failures
• Export bans/restrictions:
- Reduce global market size, increase volatili...
• Low stock levels and ill-designed policies
promote speculation
• Main categories of speculators:
- Governments
- farmers...
What food crisis?
• Political destabilization
• Macro-economic / inflation
• Poverty and hunger
The food crisis tradeoffs
+ Mass protests in more than 60 countries
+ Inflation and macro-economic imbalances
+ Environmen...
Food putting pressure on overall inflation
-2
0
2
4
Jan-05 Jan-06 Jan-07 Jan-08
Overall
Food
China, y-o-y India, wholesale...
Surge in cereal and oil prices
0
20
40
60
80
100
120
140
0
100
200
300
400
500
600
700
800
900
Maíz
Arroz
Trigo
Petroleo (...
IFPRI’s scenarios
[Models for changes in structural supply and demand factors
(2000-05 and 2006-15)]
Source: M. Rosegrant ...
The spike is not explained by
fundamentals
0
20
40
60
80
100
120
140
0
100
200
300
400
500
600
700
800
900
Maíz
Arroz
Trig...
Explanation 1: Export bans and restrictions
• Because of highly concentrated markets
• Simulations based on MIRAGE model s...
• Changes in supply and demand fundamentals cannot fully
explain the spike in food
• Rising expectations, speculation, hoa...
SOURCE: U.S. Commodity Futures Trading Commission
a. Increase in volume
0
10
20
30
40
50
60
70
0.0
1.0
2.0
3.0
4.0
5.0
6.0...
SOURCE: U.S. Commodity Futures Trading Commission
b. Open interest index
SOURCE: U.S. Commodity Futures Trading Commission
c. Future contracts: ratio volume to open interest
(monthly volume / mon...
SOURCE: U.S. Commodity Futures Trading Commission
COMMODITY: CORN - CHICAGO BOARD OF TRADE; 5,000 BUSHELS (contract code 2...
e. Evidence of causality
Indicator of speculation activity Wheat Corn Soybeans Rice
1. Monthly volume (futures contracts C...
• Spikes in prices of 3 months or more could have
severe effects over poor and their nutrition with
long term effects => f...
• Should physical, public, globally managed
grain reserved be developed?
Answer: NO
Why:
a. high storage costs
b. slow tra...
• Should we reform commodity exchanges by:
• limiting the volume of speculation relative to hedging
through regulation;
• ...
This arrangement consist of two prongs:
• A minimum physical grain reserve for
humanitarian assistance, and
• A virtual re...
• A modest emergency reserve of around 300,000
metric tons of basic grains—about 5 percent of the
current food aid flows o...
• A coordinated commitment by the group of
participating countries. Each of the countries would
commit to supplying funds ...
• The intervention will take place in the futures market => A
signal of a potential intervention will be announced
• Inter...
• The increase in the supply of future sells (short)
should lower spot prices and minimize speculative
attacks
- If there ...
• McKinnon; (1967). Futures markets, buffer stocks, and income
stability for primary producers. JPE, 75 (6), pp. 844-861
•...
What is the institutional design behind
the reserves
Country
commitment to
supplying funds
Intelligence unit
• Model funda...
Final remarks
1. Poor can not afford speculation
2. Governments can’t afford speculation
3. There is clearly a need to reg...
What could be expected?
• Food price stabilization
• Access to food supplies at reasonable and
stable prices in times of c...
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Virtual Global Food Reserve Policy to Protect the Poor and Prevent Market Failure

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Presentation at USDA
22nd of October 2008

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Virtual Global Food Reserve Policy to Protect the Poor and Prevent Market Failure

  1. 1. “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
  2. 2. 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
  3. 3. 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
  4. 4. • Low stock levels and ill-designed policies promote speculation • Main categories of speculators: - Governments - farmers, households, small traders - Commercial traders - Non-commercial traders Speculation: a symptom and a source ?
  5. 5. What food crisis? • Political destabilization • Macro-economic / inflation • Poverty and hunger
  6. 6. The food crisis tradeoffs + Mass protests in more than 60 countries + Inflation and macro-economic imbalances + Environmental sustainability consequences Political security risks Energy security risks Food security risks
  7. 7. Food putting pressure on overall inflation -2 0 2 4 Jan-05 Jan-06 Jan-07 Jan-08 Overall Food China, y-o-y India, wholesale -2 0 2 4 6 Jan-05 Jan-06 Jan-07 Jan-08 Overall Food Ethiopia 0 5 10 15 20 25 Jan-05 Jan-06 Jan-07 Jan-08 Overall Food -2 0 2 4 Jan-05 Jan-06 Jan-07 Jan-08 Overall Food Mexico Source: Data from government statistics.
  8. 8. Surge in cereal and oil prices 0 20 40 60 80 100 120 140 0 100 200 300 400 500 600 700 800 900 Maíz Arroz Trigo Petroleo (escala derecha) Sources: FAO 2008 y IMF 2008 Corn Rice Wheat Oil (right scale)
  9. 9. IFPRI’s scenarios [Models for changes in structural supply and demand factors (2000-05 and 2006-15)] Source: M. Rosegrant (prelim. results with IMPACT-WATER). 0 100 200 300 2000 2005 2010 2015 Rice Wheat Maize Oilseeds Soybean US$/ton
  10. 10. The spike is not explained by fundamentals 0 20 40 60 80 100 120 140 0 100 200 300 400 500 600 700 800 900 Maíz Arroz Trigo Petroleo (escala derecha) Sources: FAO 2008 y IMF 2008 Corn Rice Wheat Oil (right scale)
  11. 11. 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 Two explanations for the spike
  12. 12. • 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. Does speculation explain the spike in the first six months of 2008?
  13. 13. SOURCE: U.S. Commodity Futures Trading Commission a. Increase in volume 0 10 20 30 40 50 60 70 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 NumberofcontractsforRoughRice(Thousands) NumeberofcontractsforWheat,soybean,andcorn(Millions) Wheat Corn Soybeans Rough Rice Wheat Corn 1 contract = 5,000bushels Source: CBOT 1 contract = 5,000bushels Source: CBOT
  14. 14. SOURCE: U.S. Commodity Futures Trading Commission b. Open interest index
  15. 15. SOURCE: U.S. Commodity Futures Trading Commission c. Future contracts: ratio volume to open interest (monthly volume / monthly open interest)
  16. 16. 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) d. Non commercial traders
  17. 17. e. Evidence of causality Indicator of speculation activity Wheat Corn Soybeans Rice 1. Monthly volume (futures contracts CBOT) 2. Monthly open interest (futures contracts CBOT) + + (Apr/05 - Oct/07) (Dec/04 - Jun/07) + (Sep/05- Mar/08 ) + + (Jan/05- Jul/07) (Aug/05- Feb/08) + (Jan/06 – May/08) Source: von Braun, Robles, Torero (2008) - “+”: evidence of causality - Starting period of evidence of causality in parenthesis - * It combines futures and options positions, data available since January 2006. 5. Ratio non-commercial positions to total reportable positions (short) 6. Index traders net positions (long – short positions)* N/A Commodity 3. Ratio volume to open interest (1)/(2) (futures contracts) 4. Ratio non-commercial positions to total reportable positions (long)
  18. 18. • 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 Why is it important to avoid speculation?
  19. 19. • 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?
  20. 20. • 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 to do?
  21. 21. 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. What we propose A New Global Institutional Arrangement
  22. 22. • 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 1: An independent emergency reserve
  23. 23. • 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. Prong 2: A virtual global food commodity exchange
  24. 24. • 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 How the virtual reserves will work
  25. 25. • 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. Why it will work
  26. 26. • 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 Evidence that future prices could affect spot prices
  27. 27. What is the institutional design behind the reserves Country commitment to supplying funds Intelligence unit • Model fundamentals • Model dynamic price band • Trigger alarm High level technical commission • Approve intervention Appoint Futures market delivery occurs in less than 2 percent of all agricultural contracts traded Backwardation should happen
  28. 28. 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
  29. 29. 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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